Traditional IRAs can promote financial success in the short and long terms through tax-deferred contributions and distributions at retirement-age tax rates. Such distributions most directly benefit anyone age 59 1/2 or higher, as anyone younger may incur taxes and a penalty. Per the Internal Revenue Code (IRC), individuals below age 59 1/2 will sustain a 10% penalty on a premature distribution. However, IRC Section 72(t) (the 72(t) rule) allows for IRA distributions without penalty upon meeting certain conditions. Specifically, subsection 72(t)(2)(A)(vi) allows penalty-free distributions from a pre-tax account provided they occur as a series of substantially equal payments.
Questions about distributions? Send us a message through the Client Portal.
Exploring Rule 72(t)
Taxes still apply on any such distributions, but you can avoid the 10% penalty if you execute payments correctly. Withdrawals must occur over a minimum of five years until the plan holder reaches age 59 1/2 or until he or she depletes the account. Failing to meet any of these criteria could mean distribution penalties on the previous transactions. For 401(k)s, Rule 72(t) does not apply to participants still employed under their plans. Investors may implement one of three methods in calculating distribution amounts under Rule 72(t):
- Fixed Annuitization Method
- Fixed Amortization Method
- Required Minimum Distribution Method
Payments via all three methods are calculated with the applicable account balance and a factor determined by one’s life expectancy. The annuitization and amortization methods will involve interest rates chosen by the holder. Payments under these two methods will remain the same throughout the distribution period. The required minimum distribution method will not involve interest and must be calculated each year, so every annual payment will likely be different.
Knowledge is Power
Plan holders who initiate distributions under Rule 72(t) using the annuitization or amortization methods may switch to the required minimum distribution method, but they may not switch back. While the IRS provides information regarding life expectancy factors and other such specifics, New Direction Trust Company can answer your questions and provide account balance information. Please don’t hesitate to give us a call at 877-742-1270 or send us a message through the Client Portal to discuss your distribution options.