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 ½ or higher, as anyone younger may incur taxes and a penalty. In accordance with the Internal Revenue Code (IRC), individuals below age 59 ½ will sustain a 10% penalty on the amount for any premature distribution. However, IRC Section 72(t) allows for IRA distributions without penalty if certain conditions are met. Specifically, subsection 72(t)(2)(A)(vi) allows penalty-free distributions from a pre-tax IRA or 401(k) provided they occur as a series of substantially equal payments.
Any such distributions will still be taxed as income, but the additional 10% hit won’t apply if the payments are executed correctly. Qualified withdrawals must occur over a minimum of five years, until the plan holder reaches age 59 ½, or until the account is fully depleted. If any of these criteria are not met, previous transactions will be subject to IRA distribution penalties. 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):
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 (may not exceed 120% of the federal mid-term rate). 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.
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 send us an e-mail at firstname.lastname@example.org or give us a call at 877-742-1270 to discuss your distribution options.