Retiring Early? Ways to Help Avoid Early Withdrawal Penalties on Retirement Accounts

Substantially equal periodic payments are one option available to those who really need to tap their IRAs early. But be aware that can be a complicated process, and could be easy to make a costly mistake, so use this strategy only if absolutely necessary, and get some help while you're at it.

(Image credit: (C) Patrick Foto ((C) Patrick Foto (Photographer) - [None])

Unless you’re talking about retiring early, it’s unlikely your financial professional will ever mention the possibility of using something called a “series of substantially equal periodic payments” — or a 72(t) payment strategy — to take penalty-free withdrawals from your IRA before age 59½.

There’s no reason to wade into those weeds unless it’s absolutely necessary. The calculations can be complicated. There are a lot of ways to mess things up. And if you get it wrong, the penalties can be costly.

So, I’m not personally a huge fan of this complex subsection of the tax code. But I am a fan of having options. And if you find yourself in a situation where this particular strategy might suit your needs, you should know what it is and how it works.

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What is a 72(t) payment?

Typically, any amount an account owner withdraws from a traditional IRA, or any other tax-deferred retirement plan, before turning 59½ is considered an early or “premature” distribution by the IRS.

And besides paying federal income tax on the withdrawn amount, you must also pay a 10% early withdrawal penalty — unless an exception applies.

The section of the Internal Revenue Code that deals with many of these exceptions — including death, disability or using the money for educational purposes or as a qualified first-time home buyer — is called Section 72(t).

Section 72(t)(2)(A)(iv) is where you’ll find information about the exception that allows you to use a series of substantially equal periodic payments (SEPPs) based on life expectancy to withdraw money from your IRA or 401(k) for a minimum of five years, or until you reach age 59½, whichever comes later.

So, for example, if you were 50½ when you started, you would take payments for nine years. If you started at 55, you would be required to continue for five years, until you are 60.

And if you started at age 58, you would still be required to continue payments for five years, or until you reach age 63.

What is a ‘substantially equal periodic payment’?

It’s the specific amount you’ll withdraw every year from your IRA or 401(k).

The amount won’t necessarily be exactly the same every year depending on the method you choose, but it must meet the IRS’ definition of “substantially equal.”

Payments are based on life expectancy, and they can be calculated using one of three IRS-approved methods: the required minimum distribution (RMD) method, the amortization method or the annuitization method. (For more on this, see How to Avoid the Penalty for Early Withdrawals from Your IRA.)

Each will give you a different result, and you should make your choice carefully: Once you decide on the method for calculating the amount, you’ll be expected to stick with it unless you decide to switch to the RMD method. Then you can make a one-time change.

Yet another rule is that your withdrawals must come from the same IRA account every time.

If you don’t want to tie up your whole IRA in this strategy, you can use a direct rollover to split one IRA into two before you start.

But you must always use the same IRA for those periodic payments you receive.

What happens if you make a mistake?

Did I mention that it could be easy to make an error? And yet, the IRS is not at all forgiving if you miscalculate or modify your payments, or if you don’t stick to your payment plan.

If you slip, you’ll no longer qualify for the exemption from the 10% early withdrawal penalty — AND it’s retroactive, so you’ll also be penalized for all the withdrawals you took before turning age 59½.

Any changes to the IRA’s balance (other than normal gains and losses and your SEPPs) also will trigger the 10% penalty.

So, it’s hard. But what if you really need the money?

If you have a 401(k) and you are in the calendar year that you turn 55 or later when you experience a “separation from service” (leave an employer because you’re retiring, quitting, taking a buyout, or were fired or laid off), you are not required to pay the early withdrawal penalty on distributions from that employer’s plan.

That’s a far less complicated exception to the penalty on early distributions than taking SEPPs. If you roll over the 401(k) to an IRA, however, any distribution from that IRA can be penalized — so don’t move the money until you’re sure about whether you’ll need it or not.

Either way, you’ll still have to pay income tax on any distributions, so make that a part of your decision, unless you decide to switch to the RMD method — a change you can only make once.

If you’re working with an adviser, you should be covering these “what ifs” in conversations about your comprehensive financial plan.

If you haven’t (or don’t recall talking about it), and you need money for income or to cover an emergency expense, set up a meeting as soon as possible to discuss your alternatives.

Besides the difficulty, what are some other pros and cons to a 72(t) strategy?

Well, the big pro, of course, is that you can access your money years early without paying the early distribution penalty. You can execute this strategy at any age.

One downside, though, is that you’re locked into the plan. If you must take distributions during a market correction — or worse — you could find yourself selling at a loss. That’s never a good thing — but it’s especially challenging when you’re in retirement.

Once you’ve considered all your options, if you’re still tempted to go with 72(t) payments, I strongly recommend against trying to DIY it. There are online calculators for figuring out your SEPPs, and you can run the numbers there to see how it might work for you.

But there are so many ways for this strategy to go wrong. You really should consider getting help from a financial adviser or tax professional before you move forward.

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Kim Franke-Folstad contributed to this article.


Appearances on were obtained through a paid PR program. The columnist received assistance from a public relations firm in preparing this piece for submission to Kiplinger was not compensated in any way.


This article was written by and presents the views of our contributing adviser, not the Kiplinger editorial staff. You can check adviser records with the SEC or with FINRA.

Scott Tucker, Investment Adviser Representative
President, Scott Tucker Solutions

Scott Tucker is president and founder of Scott Tucker Solutions, Inc.  He has been helping Chicago-area families with their finances since 2010. A U.S. Navy veteran, Scott served five years on active duty as a cryptologist and was selected for duty at the White House based on his service record. He holds life, health, property and casualty insurance licenses in Illinois, has passed the Series 65 securities exam in 2015 and is an Investment Adviser Representative.