Avoid early IRA withdrawal penalties by using the 72(t) rule

Have you been saving for your retirement? If you’re making a high enough income, you’re likely building up healthy retirement savings. If you’ve also been receiving a match on your contributions from your employer to a 401(k), you’re likely doing even better. But regardless of which retirement accounts you’re using, you’ll face the hefty 10% penalty for early withdrawals if you’re younger than 59½.

Even if you’ve saved a lot of money in retirement accounts, you may become tempted to withdraw some of the funds. If you want to do so while avoiding penalties, there’s the IRS 72(t) rule.

What Exactly Is The 72(t) Rule?

Rule 72(t) is an IRS rule that allows you to make penalty-free withdrawals from your:

– 401(k)
– 403(b)

The “rule” is referencing Code 72(t), section 2. That section lays out the circumstances under which you can bypass the early withdrawal penalty.

If you want to use the rule to make early withdrawals without a penalty, you can. You just need to follow the regulations laid out in the rule. It should be noted that you will still owe tax at your ordinary tax rate for the withdrawals but they will be penalty-free.

Substantially Equal Periodic Payments

To make early withdrawals from your IRA without the penalty, you need to make at least 5 Substantially Equal Periodic Payments (SEPPs). That means you need to set up payments that occur either:

– Over the span of 5 years, or
– Until you reach age 59½ 

The payment sums and number of payments you make will be based on your life expectancy. Your life expectancy must also be calculated through IRS-approved means.

Calculating Your SEPPs

Rules surrounding the amount that an account holder receives in their periodic payments are provided by rule 72(t). Determining life expectancy by IRS standards is possible through 1 of 3 ways.

Minimum Distribution Method

To use this method, find your age on the minimum distribution IRS table. It will tell you which divisor you will use for your age. You’ll then divide last year’s year-end (December 31st) account balance by the number you found on the IRS table. The result will be your distribution for this year. This method will see your annual early withdrawal payments likely vary year-by-year. But overall, they should remain fairly consistent.

There is one thing to keep in mind with the minimum distribution method. As its name implies, the payment scheme that results will allow the lowest possible amounts to be withdrawn.

You’ll have to recalculate your allowed withdrawal amount every year because you’ll have to apply for a new number from the IRS minimum distribution table for each passing year.

Amortization Method

This method determines your payments’ sums by amortizing your IRA’s balance over your single or joint life expectancy. It determines the most reasonable fixed amount you can remove on an annual basis. 

The difference with the amortization method is that it allows the largest amounts you can reasonably be enabled to withdraw from your IRA.

To use this method, you’ll need an annual withdrawal schedule. You’ll have to take your most recent account balance and assume a reasonable interest rate. You cannot use a rate of over 120% of the mid-term Applicable Federal Rate. After that, you’ll create a payout schedule based on the IRS life expectancy table. There are multiple tables, so you’ll have to choose from:

– Single life
– Joint life
– Uniform life

Annuitization Method

Lastly, this method provides equivalent or nearly-equivalent payments as per SEPP regulations. It will land you a fixed annual withdrawal based on the annuity factor method offered by the IRS. The payments will typically fall in between the highest and lowest possible withdrawal amounts.

Alternatives To Rule 72(t)

If you aren’t able to take advantage of the 72(t) rule, there are other methods that allow you to make early IRA withdrawals while bypassing the 10% penalty. 

Healthcare Insurance Payments 

While you’re unemployed, you have the option of early IRA withdrawals. The penalty-free withdrawals can be used to pay for medical insurance so long as:

– You’ve received state or federal unemployment compensation for 12 consecutive weeks.

– You received your IRA withdrawal either:
    1) On the year you received your unemployment compensation 
    2) The year after

– If you’ve found employment, you cannot make your withdrawal more than 60 days after your employment started.

Medical Expenses 

If you used an IRA withdrawal to pay for large medical expenses, you may be exempt from the 10% penalty. The medical expenses must total at least 10% of your adjusted gross income to qualify.


If you have a doctor-verified disability, you may qualify for an exemption to the penalty. To qualify, you must be able to provide proof that you aren’t capable of “substantial gainful activity” due to a physical or mental condition.

Higher Education

Some higher education expenses can be exempt from the early withdrawal penalty. But only IRS-qualifying expenses, such as tuition, fees, books, and supplies, can exempt your withdrawal from it. However, IRA withdrawals are taxable income and can reduce your financial aid eligibility.

Home Purchases

You can use up to $10,000 for a single taxpayer and $20,000 for a couple in early IRA withdrawals to pay for the purchase, construction, or rebuilding of a home for your spouse, an older relative, yourself, or your spouse’s child or grandchild. The caveat is that this benefit is only available if you qualify as a first-time homebuyer.

Military Service

If you are in the military reserves and take an IRA distribution during a  period of active duty of more than 179 days, you are exempt from the 10% penalty.

We’d recommend you look into all your available options and consult a financial advisor before using the 72(t) rule.

That’s because withdrawing substantial amounts of money from your IRA is typically not advisable. That’s why the IRS has strict guidelines and few exceptions regarding early withdrawals. You’ll want to make sure your early withdrawals are well-planned and as efficient as possible.

Your IRA isn’t an emergency fund. That’s why there are specific early withdrawal exceptions for medical expenses and disabilities. Using the 72(t) rule will significantly impact your future financial security and stability.

How You Can Apply The 72(t) Rule

If you’ve determined that the 72(t) rule is the right option for you, it’s time to start planning how you’ll use it.

Determine Your Best Withdrawal Option

You’ll first need to determine which of the 3 SEPP methods you need to use. You don’t need to make serious calculations on your own. There are rule 72(t) calculators that will do that job for you. But it’s important to know how each payment distribution method works.

The three withdrawal options are standardized and thus not customizable.

Calculate Your Payouts

If your head is mush right now trying to figure out how to perform these calculations, don’t despair! Here are two online calculators to help you at CalcXML and Bankrate. With knowledge of all three payment schedules, you’ll be able to choose the most suitable option. 

IRA Rollovers

While you can’t insist on your own payment schedule, you can use IRA rollovers to adjust the balance of the IRA you want to withdraw from. Just roll over your funds and set up your SEPPs after.

Withdrawing from or making any changes to your retirement accounts is a significant financial decision. Doing so comes with many restrictions. These decisions also have a lasting impact on your financial future.

To ensure you make the best possible decision, you should reach out to us before making such a significant decision. In the end, that’s the best way to ensure your current needs are met while making the lowest possible negative impact on your savings.