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It can get you early access to your IRA's earnings—but tread carefully using this little-known rule

Quick Summary

  • Rule 72(t) allows you to take money out of a Roth IRA before the age of 59½ and avoid the 10% early distribution penalty tax.
  • Under Rule 72(t), you make withdrawals in specific amounts (SEPPs) on one of three IRS-approved schedules, based on life expectancy tables.
  • Once begun, you must continue withdrawals for five years or until age 59½, whichever comes later.
  • You can no longer contribute to your account or take additional distributions once you begin Rule 72(t) payouts.

Almost all Roth IRA investors have had it beaten into their heads that they cannot withdraw their investment earnings from a Roth until they reach the age of 59½ without paying a 10% penalty.  But what if there were a way to get at your capital gains, dividends and accrued interest earlier than that?

In fact, there is. Rule 72(t), named after the section of the IRS code it appears in, lets you get access to those Roth IRA earnings—and in fact, all the money in your Roth—without penalties. It can be a boon to early retirees or those in a real financial bind.  First, though, you have to jump through a few hoops.

How Rule 72(t) Works

Rule 72(t) actually refers to Internal Revenue Service code 72(t), section 2, which deals with early withdrawals from tax-advantaged accounts (it applies to traditional IRAs and 401(k) plans too). Basically, it exempts you from the usual withdrawal penalty if you take the funds according to a specific schedule. This schedule dictates you receive the money in at least five payments, called substantially equal periodic payments (SEPPs). The size of the payments is figured based on one of three IRS-approved approaches: the amortization method; the minimum distribution method; or the annuitization method. All these schedules are derived from what the IRS considers your life expectancy, based on its own tables.

Important: When you start making 72(t) withdrawals, you must stick with the payment schedule for five years or until you reach age 59½, whichever comes later.

Once you start making SEPPs, you can no longer contribute to the IRA, or withdraw other sums from it.

Rule 72(t) Payment Plans

You can’t decide how much you want to withdraw; the IRS sets the size of the payouts, based on the method you elect. You don’t have to crunch the numbers yourself—there are online 72(t) calculators for that—but here’s how the methods basically work.

The amortization method determines a yearly withdrawal schedule by amortizing the latest balance of the IRA, using a single life expectancy (yours) or a joint life expectancy (usually with your IRA beneficiary) or a uniform life table. This method usually results in the largest possible payment, a fixed annual sum.

With the minimum distribution method, you divide the IRA’s previous year-end balance by a divisor—provided in an IRS table, based on a single or joint life expectancy—and the resulting figure is the amount you can withdraw this year. You have to re-do this calculation annually, based on your account’s latest year-end balance and your attained age. But, as the name implies, it usually results in the smallest possible payout, though of course, the size will vary each year.

With the annuitization method, we’re back to fixed annual payments—larger than those under the minimum distribution, but less than those in the amortization method. To get the sum, you take the most recently reported IRA balance and divide it by an annuity factor, again furnished by the IRS.

As an example, assume a 53-year-old woman who has a Roth IRA with $250,000, earning 1.5% annually, and who wants to withdraw money early under rule 72(t). Using the amortization method, she would receive approximately $10,042 in yearly payments; with the minimum distribution method, she would receive around $7,962 annually; with the annuitization method, she’d receive approximately $9,976.

Once you settle on a method, you have to keep taking payments under its schedule. You are allowed to change once, to the minimum distribution method if you didn’t opt for it originally.

Alternatives to Rule 72(t)

Rule 72(t) withdrawals are not something to be started or taken lightly, given all the restrictions on them. Deviate from the schedule, and the IRS will slap you with penalties for all the funds you’ve withdrawn.

So, before you go down this path, investigate other ways to tap the account. Roth IRA-holders actually have several alternatives.

Contributions Count First

First of all, remember that, if the need arises, you can withdraw the principal that you put into a Roth IRA penalty-free at any time, at any age. You are not allowed to touch any interest, dividends, or capital gains that have accrued without triggering an early withdrawal penalty, but the amount that you contributed is always available to you—one of the Roth’s big advantages over its traditional IRA cousin.

The IRS considers the first amount of money you withdraw to be part of the principal that you invested. Let’s say you contributed $5,000 into a Roth IRA each year for five years and your account grew to be worth $30,000. If you then withdrew $10,000, the IRS would consider that entire $10,000 to be part of your original $25,000 in contributions. In this example, your remaining account balance of $20,000 would count as $15,000 in contributions, $5,000 in investment gains.

Exceptions to the Penalty

Ok, so you need to withdraw more than your total contributions. In certain situations, you still can be exempt from the 10% early withdrawal penalty. For example, the IRS allows you to withdraw funds—both principal and interest—from your Roth IRA for a first-time home purchase, qualified higher education expenses, a severe disability, and several other specific scenarios. You can see the entire list of exemptions to the 10% penalty on the Internal Revenue Service’s website.

Withdrawing funds from your Roth IRA before you retire, while an option, should be a last resort. And Rule 72(t) payments should be the last of the last resort. Remember, a Roth IRA was not created as a savings account to dip into when the going gets tough. Unless it’s really tough, of course.

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