The 72t rule refers to IRS code 72t (section two), which allows IRA owners to access their retirement savings before they reach 59.5 years of age, without incurring the typical 10% penalty for early withdrawals. The withdrawals
are still taxed at the owner’s current income tax rate.
The 72t exemption necessitates that IRA owners take at least five “substantially equal periodic payments” (IRS). These payments must occur over the span of five years, or until the owner reaches 59.5 (whichever time period is longer).
The amounts an IRA owner receives in the periodic payments as qualified by the 72(t) exemption depend on the account owner’s life expectancy, which can be calculated through one of following three IRS-approved methods: the amortization method; the minimum distribution method (aka the life expectancy method); or the annuitization method.
The amortization method calculates yearly payment amounts by amortizing the balance of an IRA owner’s account over single or joint life expectancy. The amount in this method is fixed annually.
The minimum distribution method uses a dividing factor from the IRS’ single or joint life expectancy table to divide the retirement account’s balance. With this method, the annual payments are likely to vary slightly each year. As the name implies this method provides the lowest possible amounts that can be withdrawn.
The final IRS-approved calculation is the annuitization method, which uses an annuity factor defined by the IRS to determine equivalent yearly payments. This method offers IRA owners a fixed annual payout. The withdrawn amount is typically somewhere between the highest and lowest annual amount that can be withdrawn by the account owner.
Example from Forbes.com:
“Assume a 53-year-old woman who has an IRA earning 1.5% annually, with a balance of $250,000, wishes to withdraw money early under rule 72(t). Using the amortization method, the woman would receive approximately $10,042 in yearly payments. With the minimum distribution method, she would receive around $7,962 annually over a five-year period. Using the annuitization method, approximately $9,976 would be her annual payment amount.”
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