Another Way to Access Retirement Money

September 15, 2018

The biggest investment account that we see in many divorce cases is a retirement account, typically an IRA or 401(k). On occasion, this account must be tapped into to access cash needed to buy a new house, for living expenses, or other needs. Unfortunately, account owners under age 59 ½ will pay a 10% penalty with every withdrawal on top of paying income tax at their ordinary tax rate, which could reduce the gross withdrawal by 20% to 45%. However, there is a way to take a withdrawal from an IRA (or 401(k) if the owner no longer works for that employer) without the 10% penalty. It’s called a “72-T” withdrawal.

72-T refers to the IRS tax code section that outlines this rule, which allows an individual to take “substantially equal periodic payments” over a period of 5 years or to age 59 ½, whichever is longer. The withdrawals will still be subject to income tax but will avoid the 10% penalty. Once set up the payments must continue for the full period and cannot be stopped or changed without penalty.

The IRS offers three different ways of calculating the withdrawal:

  1. Required Minimum Distribution: The retirement account balance is divided by a factor which is based on the client’s age. As the client’s age goes up each year, the factor goes down over the 5 years, resulting in an increased payment every year.
  2. Amortization: This method uses the individual’s life expectancy, account balance and a reasonable interest rate (any rate that is reasonable and not more than 120% of the Applicable Federal Rate) to calculate a fixed payment that is fixed over the withdrawal period.
  3. Annuitization: The account balance is divided by a factor that is based on the client’s age. The factor is derived from the mortality table in IRS Revenue Ruling 2002-62. As in option 2, this fixed payment is then withdrawn each year.

The IRS allows the account owner to choose the method that will give them the payment most beneficial to their situation.

If all of the methods above result in an annual payment that is more than desired, the retirement account can be split into two accounts, one with the right value that results in the needed level of income, and the 72-T withdrawals applied to this account alone. It is important to have an accountant calculate the withdrawal so the owner ensures the IRA has enough assets to cover all of the required payments.

Once established, the 72-T plan cannot be changed, nor can additional money be taken out of the account. After the required period is satisfied (5 years or to age 59 ½, whichever is longer) the owner is free to stop payments or change the payment amount.

This withdrawal option could be helpful to a client who needs an income stream for a limited time of at least 5 years and is not yet 59 ½.

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