IRS Code 72t for Early Withdraw of Traditional Retirement Funds

Those fortunate to have reached a FIRE status have the “burden” of managing many moving parts of their family’s financial life such as funding everyday expenses, managing income tax exposure, and managing the flow of income from various sources.  Personally, Mrs. FiredUp and I are looking at tax exposure not only today, but over 20 years out.  Why? Required Minimum Distributions. 

What Impact will RMD Have on Your Tax Situation 20 Years From Now?

During our working career, we have the opportunity to reduce our annual Adjusted Gross Income by making contributions to Traditional 401k/IRA and similar retirement accounts and to defer income tax exposure for years, likely many decades, into the future.  This is especially true for those who are in the upper tax brackets during their working years and who anticipate being in lower tax brackets during retirement years.

For those dealing with this challenge, age 70 ½ could become problematic if you have not planned prudently to ensure a steady annual withdrawal to avoid a “big” surprise when RMD’s kick in at age 70 1/2. 

Those fortunate enough to have many levers to draw on with both retirement and non-retirement funds have tremendous control.  These levers may include the rollover of Traditional retirement funds to Roth accounts, especially in years where the Adjusted Gross Income is in lower tax brackets. 

Does a Traditional to Roth Conversion Make Sense?

When we ran the calculator to see if rollovers from Traditional accounts to Roth accounts made sense, we found they do not for our situation.  Now what?

IRS Code 72t – what is it?

IRS Code §72(t) allows for the withdrawal of Traditional retirement funds from 401k’s, 403(b)’s including Qualified Annuities, Pensions, Individual Retirement Accounts (IRA’s), or any other tax deferred retirement savings vehicles prior to age 59 ½.  The use of IRS Code 72t can be a powerful option for spreading out withdrawals from these accounts over a much longer time period rather than “forcing” large withdrawals after reaching age 70 ½. 

Mrs. FiredUp and I are both in our early fifty’s and have about ½ of our net worth in Traditional retirement accounts.  The ability to spread the withdrawals from these accounts over an extended period of time allows us the flexibility to closely manage the tax brackets we fall into, leading to a much more efficient use of this money.  The IRS website that explains this strategy and requirements in more detail is provided below:

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-substantially-equal-periodic-payments

What National Debt?

We anticipate that tax law changes following expiration of the current tax code will result in significantly higher federal income tax exposure.  At some point the government will have to “bite the bullet” and address the national debt, right? We want to anticipate and control our exposure to these future tax laws.  We can leverage one or more of the “non traditional” approaches to managing tax exposure while funding retirement needs over a significantly longer period of time. 

Be Prudent in your approach

The use of IRS Code 72t is one of these options.  Use of the 72t option requires development of a plan to make substantially equal withdrawals over a period of at least five years, or until you reach age 59 ½, whichever is longer.  Penalties associated with mistakes in the execution of the plan can be very expensive, so the use of a tax professional to setup the plan and assist with ensuring adherence to the plan is strongly suggested.   

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