Most people are aware that they need to wait until they’re 59 1/2, or older, to withdraw money from their IRA without tax penalties. Many are unaware that they could, if needed, withdraw money from their IRA without penalty.
This post isn’t about what is called 72t or Substantially Equal Periodic Payments per se. There is plenty written about the rules, how the work, and what to avoid. Rather, I will look at an even lesser known strategy that suggest paying the penalty may be okay – as long as the need to withdraw from the IRA is temporary.
So, IF your need for money for expenses is temporary, such as for a changing your job or career, then what is the breakeven point where you would pay less taxes, even with the penalty, compared to having to pay taxes for the full 5 years (if you start at age 58, you need to continue the plan for 60 months (5 years) to age 63)? You see, once you start a 72t plan, you can’t change it without the penalty being applied to the whole period since you started the plan. So be careful and understand if your situation is temporary or permanent (disability for example). Once you start a 72t plan, you can’t stop it until you’ve paid 60 months worth of taxes or reached age 59 1/2, whichever is later; in other words, more than 60 months of taxes.
There’s a breakeven number of months with penalty where you would pay less in taxes and penalty without the 72t plan, than you would pay in just taxes under the 72t plan. If your temporary period is less than the break even point stated in the figure, you don’t need to start a 72t program because even with penalty, taxes and penalty would be less than taxes paid under a 72t program. Please click on the figure to enlarge (hold the shift key and then click to open it in a new window).
Therefore, if your situation is temporary where you can stop withdrawing from your IRA before the breakeven number of months. Paying the penalty costs you less than beginning a 72t program. Why? Because you are committed to pay the taxes for the complete period even if you don’t have to take money out of your IRA anymore (hence, temporary need).
Note: the math for breakeven is stated below.
- If you opt to not do a 72t plan, pay penalties for a short period of time, and then begin a 72t plan later, you will end up paying more taxes overall.
- Any withdrawals from any retirement plan (even loans), hurts your retirement.
PS. Bonus – How Long Should a Job Search Take?
PPS. Kitces and the IRA aggregation rule on 72t’s.
The Rule is: 5 years, or until 59 1/2, whichever is LONGER
Y years * (X% + 10%) * $100,000 = 5 years * (X%) * $100,000
where (X% + 10%) represents the tax & penalty and (X%) = your tax bracket
Divide out $100,000 (or any dollar amount — i.e., $$ are not a factor)
Y years * (X% + 10%) = 5 years * (X%)
Y years = 5 years * (X%) / (X% + 10%)
Y = 5X / (X+.10)
Federal taxes are only considered. You may incorporate any State tax and penalty into the formula for your State (not considered here due to the many different State tax rules).
Note: Your RSS feed or email may not show the embedded part of this blog … please go to the blog to be able to read the complete post.