By: Dr K C Gupta, YBB Personal Finance

Some people hesitate to contribute to IRA, 401k, 403b because they fear that the
money would be locked up until retirement. While the retirement money shouldn’t be
tapped for ordinary expenses, or kids’ college education, there are ways to tap
retirement money without penalties (but there is no escape from taxes).

Roth IRA contributions can be withdrawn without penalty (or tax) anytime. And Roth IRA
can be used for any purpose in retirement.

Specific 401k/403b can be tapped early & penalty-free if the associated job loss is
between the age 55-59.5, while the IRAs cannot be. So, don’t rush into rolling over
401k/403b into IRA after job loss.

Use 529 or loans for kids’ education. Remember that you can get loans for kids’
education, but nobody will loan you money for your retirement.

Now the topic of this article. An important exception for penalty-free early withdrawals
(before age 59.5) from tax-deferred/ free retirement accounts is the uniform withdrawal
method, called the 72T/SEPP exception. These withdrawals are taxable.

SEPP = Substantially Equal Periodic Payments; 72T refers to the IRS code section.
Withdrawing uniform amounts (monthly, quarterly or annual) must be based on a
“reasonable” interest rate over the “life-expectancy”; IRS provides guidelines, but the
overall rules are complex.

Once started, these withdrawals cannot be stopped until the later of (i) 5 years or (ii)
age 59.5 even if at some point you don’t need these taxable payments. Keep this in
mind if you are considering 72T at an early age. A violation (e.g. early stoppage) will
cause a 10% penalty on all your SEPP payments, past & current. You may want to use
broker’s or fund firm’s AWP (automatic withdrawal plan) or SWP (systematic withdrawal
plan) to avoid mistakes of missing the SEPP payments & triggering the early stoppage
penalty.

There have been some recent changes in these rules. First, after the modification of the
RMD tables (effective 1/1/22), the IRS has also modified other life-expectancy tables.

This is a slight negative for 72T as the new life-expectancies are a bit higher & that will
reduce the withdrawal amounts slightly. Another more significant change is in the
“reasonable” interest rate – it can be higher of (i) 120% of the federal midterm rate or (ii)
5% (so, the rate floor is 5%). This rate modification was to account for rather low current
rates during the ZIRP era & will significantly increase the withdrawal amounts.

SECURE 2.0 has also modified some rules about transfers & rollovers. For example,
one old rule prohibited transfer & rollover to or from an account running a 72T program unless the entire balance was rolled over or transferred to a new account. Secure 2.0 repealed that limitation for rollovers & transfers made after 2023—including partial transfers & rollovers—provided the total annual payments equal the amount initially established under the program.

Lifetime Annuitization may count as 72T exception depending on circumstances. The
IRS allows 3 methods that include an “Annuitization Method” – it requires the use of a
reasonable interest rate for uniform distributions over life-expectancy; there are also
restrictions on when such a program can be terminated & other restrictions on the
account running the 72T-SEPP. Slightly different rules apply for qualified (401k/403b) &
nonqualified (IRAs) accounts. To avoid problems, complete the 72T-SEPP (before 59.5)
as required & then, if desired, buy lifetime income annuity at the end of the 72T
program. A later start for lifetime annuitization (in 60s or 70s) may be better anyway.

For simplicity, the IRA owners & plan participants should keep 72T account balances
segregated from other amounts. Doing so will help to maintain the integrity of the
program & avoid any risk of breaking any of the rules—particularly failing to withdraw no
less or more than the payment amounts due for a year. The IRA holder must keep good,
detailed records & the IRS Form 5329 may have to be filed for penalty waiver. The IRA
sponsor may treat this as any other systematic withdrawal program with all the
flexibilities, so the onus is on the IRA owner/holder to follow all the 72T-SEPP rules.
For more information, see https://ybbpersonalfinance.proboards.com/