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Keeping The Boat Afloat

For recently unemployed clients short on cash, try using 72(t) to withdraw penalty free from the client’s IRA. Here’s how to do it.

The millions of freshly unemployed workers out there probably have a lot on their minds. For starters, there's the negative cash flow they can expect in the short-term, and the impact that will have on their long-term retirement plans. You can expect even more angst among those who haven't hit “retirement age,” but whose main paper asset is a tax-sheltered retirement plan.

If you have clients who've lost their jobs, you can minimize their anxiety and maximize their short-term cash by using the little-known 72(t) regulation to get money penalty-free from their IRAs even before the clients are officially retired.

Tax Strategy

Usually, clients taking money out of IRAs before turning 59½ are liable not only for income taxes on the distribution, but also for a 10 percent penalty on the withdrawn amount. Adding this insult to injury can cause unemployed clients with even moderate spending needs to suffer as much as a 40 percent haircut on a dollar taken from retirement plans to cover living expenses.

But there is a provision that allows clients to get access to their IRA assets before turning 59½, and at least avoid the onerous 10 percent penalty. Under Section 72(t) of the tax code, clients can make penalty-free withdrawals from their IRAs as long as they take “substantially equal periodic payments” (SEPP) at least annually, and for at least five years or until they turn 59½ — whichever is longer.

The withdrawn amounts are based in part on the life expectancy of the IRA owner (and possibly the beneficiary, if he or she is married to the IRA owner). Other factors can include the account balance, the applicable federal interest rate and the chosen method of calculating the payment amount.

Three Ways To Get Paid

The IRS allows the IRA owner to choose one of three methods to determine the SEPP amount: required minimum distribution, fixed amortization and fixed annuitization. The RMD method applies the same math that is used when IRA owners turn 70½: Each year the owner uses a divisor based on his (and perhaps his beneficiary's) age to determine how much should be withdrawn. This method will cause the required amount to vary from year to year.

The fixed amortization method calculates the amount based on the single or joint life expectancy tables in IRS Publication 590, along with the applicable federal rate. Once the initial calculation is made, the amount will remain the same each year. Meanwhile, the fixed annuitization method, when distributed over the IRA owners' life expectancy, is based on the present value of the IRA. It is also a fixed payment, determined in part by the applicable federal interest rate. IRA owners choosing the fixed amortization or RMD methods must also decide which one of three life expectancy tables (located in IRS Publication 590) they will use to further determine the withdrawal amount.

Clients who choose either of the fixed options get one opportunity over the duration of the SEPP to switch their distribution calculations to the required minimum distribution method. But IRA owners who start their SEPP with the RMD method are stuck with it until either five years have passed or age 59½ is reached.


Clients with larger IRAs may find that even when using the formula that produces the lowest amount, the distribution required is more money than needed, and therefore triggers more income tax than they would prefer to pay.

The IRS feels their pain, and allows them to split one IRA into at least two separate accounts: one that will generate the SEPP amounts, and another that will be left intact until needed at a later date (preferably after the client turns 59½).

So if a 50-year-old client with $800,000 in an IRA finds that he only needs the income that a $300,000 amount will produce, he can transfer that amount into one IRA, and leave the remaining $500,000 out of the equation.

Once clients get back on their proverbial feet with a new job and income, they will naturally want to stop taking the now-unneeded 72(t) payments. However, unless they have reached age 59½ or have been taking payments for at least five years (whichever happens last), they can't stop.

They can, however, turn around and make tax-deductible contributions to a pre-tax retirement plan like an IRA or 401(k). This can offset the tax bill incurred by the SEPP withdrawals. But keep in mind that the contribution can only go into an IRA that is not kicking out SEPP money. Otherwise, the clients may incur a 10 percent penalty on all the previously-distributed amounts.

Stay Informed

Once you have a client who is interested in pursuing SEPP withdrawals from a retirement plan, the next step is to contact your firm's IRA department to get the paperwork started.

But you should also bring in a tax attorney or CPA to review the deal for any potential snags. The client should be part of the review, and be aware of the benefits and pitfalls of adopting the SEPP. In the meantime, you can get more information from Publication 590 at, or run some quick calculation scenarios at

If avoiding the 10 percent early withdrawal penalty seems like a lot of work, you can at least enjoy the satisfaction of helping clients save a considerable sum of money at a time when he is in dire need.

Plus, knowledge of the nuances of 72(t) withdrawals could help you garner quite a few more assets from other less-informed advisors … and keep you from joining the ranks of the unemployed yourself.

Writer's BIO:

Kevin McKinley
CFP© is Principal/Owner of McKinley Money LLC, an independent registered investment advisor. He is also the author of the book Make Your Kid a Millionaire (Simon & Schuster), and provides speaking and consulting services on family financial planning topics. Find out more at

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