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Regulation 72t. Distributions and early IRA withdrawals There are certain ways that you may access your IRA without incurring the 10% early withdrawal penalty. In most cases, early withdrawals from a retirement account prior to age 59 1/2 are subject to a 10% early withdrawal penalty. If certain criteria exists at the time of the early distribution the penalty may be avoided. Under IRS section 72t there are several situations where the early withdrawal penalty may be waived. These situations may include:
The 72t rule and Substantially Equal Periodic Payments The early withdrawal penalty does not apply if the money is taken in substantially equal periodic payments. With substantially equal periodic payments, they must be taken over a period of at least five years or until age 59 1/2. At the end of the five year period an individual is able to change the amount, but not before. Payments may be stopped altogether at this time as well. The key thing to remember is that five years of substantially equal periodic payments must be completed before any changes can be made. Once payments begin, if they are altered for any reason other than death or disability, the 10% penalty plus interest will be imposed on all payments previously received. The IRS also views periodic payments as at least one payment per year. 72t Calculation Methods The IRS uses three calculation methods for reg.72t. distributions. These calculation methods are life expectancy, amortization and mortality. Substantially equal periodic payments are based upon these three calculation methods. The 72t. distribution will not reduce your account to zero over the payment period. Many people make the mistake of thinking that payments will be whatever their account value is divided by five years. This in not the case at all. Payments are determined by the calculation method selected. Life Expectancy - IRS life expectancy tables are used. Payments under this method will vary from one year to the next reflecting your current account value and age. Amortization - Uses an interest rate declared by the company based on IRS federal rates and your life expectancy. This method creates a level payment. Mortality - Uses an interest rate declared by the company based on IRS federal rates and an annuity factor determined by your age and gender. This method creates a level payment. 72t Example Lets assume that you are 43 years old and recently laid off from your job and that you have $100,000 in your retirement plan. There are also many bills that must be paid in addition to the uncertainty of what the future may hold in terms or employment opportunities. In this situation many people decide to take their money in cash. This usually proves to be a very costly mistake. If a lump sum distribution is taken then your retirement nest egg will be reduced by taxes and the early withdrawal penalty leaving you with only $58,000. In this case if you had rolled over the retirement account into an IRA you would still have your principal growing on a tax-deferred basis and you could elect to take substantially equal periodic payments. The substantially equal periodic payments could help you cover your bills and maintain your standard of living without incurring a large tax bill and early withdrawals penalty that would erode a substantial portion of your nest egg.
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