Dipping into an IRA Without a Penalty

May 4, 2022

Louise is working out her divorce from Matt. They have agreed that Louise will keep a small bank account, the equity in the house and a $600,000 IRA.

Louise is 57 and is going to need some money from the assets she is awarded until she is eligible for Social Security. That is a minimum of 5 years (if she chooses to begin Social Security at the earliest age of 62.)

Until Louise is 59 ½, she will pay a penalty for withdrawing money from retirement accounts. For the next 2 ½ years she would owe income tax plus a 10% penalty on every dollar she takes out of her IRA. Fortunately for her, there is a way around this penalty.

Before we get into the details, you may have read some of our past newsletters which focused on the ability of a spouse to take money penalty-free from a 401(k) pursuant to a divorce (although it was way back in 2016!) That strategy, in which a QDRO is written with specific language allowing the withdrawal so that it avoids the IRS penalty, is applicable only to 401(k)s. It does not apply to IRAs (as a QDRO is not required or used to divide an IRA.)

There is a strategy for avoiding the 10% penalty that is applicable to IRAs. It also applies to other tax-advantaged accounts such as Roth IRAs, SIMPLE IRAs and even 403(b)s and 401(k)s from old jobs. It is called a Rule 72T withdrawal, after the IRS code section.

If the IRA owner takes substantially equal periodic payments (SEPPs) over a period of at least 5 years and adheres to the following rules for those payments, then there is no 10% penalty.

Because the payment depends on the account value, an IRA owner who doesn’t need or want a withdrawal based on the total value of their IRA, can unequally divide the account into two separate IRAs and apply the 72T withdrawals only to one of them.

Louise is considering creating a second IRA account and transferring in about half the value of her existing IRA. She’ll then take withdrawals for 5 years at which time she will begin Social Security.

The Rule 72T strategy is different from the 401(k)-withdrawal strategy mentioned above in that it requires payments over a period of at least 5 years. It doesn’t solve the problem if the owner needs a one-time distribution, but it can help your client who needs payments over a 5-year or longer period.

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