Last week, I wrote about one strategy for accessing the funds in your retirement accounts early. This strategy is called a **Roth Conversion Latter**. The Roth Conversion Latter involves converting money from your Traditional IRA to your Roth IRA.

In this week’s post, I tackle a second method that enables you to pull money from your retirement funds early * without paying the 10% penalty*. The second method is called Rule 72(t) – Substantially Equal Period Payments (SEPP.)

This method is calculation intensive and I recommend checking with a tax professional if this is a method you plan to implement. In this post, I will highlight the following:

- How Rule 72(t), also known as SEPP, works from a high level
- The rules for how many years you need to withdraw from your IRA
- The three methods for calculating the amount you can withdraw each year
- An example from the Mad Fientist comparing SEPP versus other withdrawal methods
- Cautions to be aware of regarding SEPP
- My take on SEPP and if I plan to implement it

## How does Rule 72(t) work?

The SEPP rule enables you to withdraw funds from your IRA before you turn 59 1/2 **without** paying the 10% early withdrawal penalty. Before I dig into this in detail, I recommend checking with a tax professional if this is something you want to do.

If you make a mistake in calculating how much you can withdraw each year, you will have to pay taxes and potentially penalties on each distribution you’ve taken.

Another caution with SEPP is the length for how long you have to withdraw money. The SEPP plan requires you to withdraw money each year until you turn 59 1/2 or for at least five years, whichever is * longer*. You can keep withdrawing indefinitely if you choose to.

For example, if Joe implements SEPP at age 44, he must make a withdrawal each year from age 44 through age 59 1/2. However, if Joe was 57, he would only have to make withdrawals until he reached age 62 (5 years).

If you deplete your account, you no longer have to make withdrawals. Or, if you become disabled or die you no longer are required to make withdrawals.

### How is the annual withdrawal amount calculated?

There are three methods for calculating the amount you will withdraw each year.

- Required minimum distribution method
- The amortization method
- The annuitization method

The required minimum distribution method is calculated by taking the account balance and dividing by the expectancy factor of the taxpayer and the beneficiary (if applicable.) **Each year, the annual amount needs to be recalculated.**

The annuitization method, similar to the amortization method, provides the same amount each year. The amount you receive each year is determined by an annuity based on the age of the taxpayer and a chosen interest rate.

The amortization method calculates a payment based on life expectancy of the taxpayer and his or her beneficiary and a chosen interest rate. This payment will be the same payment each year the SEPP is in effect. The interest rate is calculated by using the federal mid-term rate. The federal mid-term rate is provided each year by the government and the interest rate in the SEPP calculation can be up to 120% of the federal mid-term rate.

## Helpful Resources

The **Mad Fientist** completed an analysis comparing **SEPP vs. Roth Conversion Latter vs. paying the 10% early withdrawal penalty**.

Here is a quick snapshot from that analysis. In this example, a single lady contributes $18k pre-tax/year from age 30 to age 40. This analysis compares saving into a taxable account, different traditional accounts, and a Roth. At age 40, this lady retires and lives off her investments. Long-term, the SEPP performs the best – this lady is able to live until age 90 before her money runs out.

**Vanguard **also has a nice write up **here**. Vanguard summarizes much of what I covered in this post. If you invest with Vanguard, you should be eligible to get free advice on how to best execute SEPP.

Finally, I recommend checking out the **IRS website**. They have a frequently asked questions page that is quite helpful.

## Cautions when considering SEPP

- If you pull from a Roth IRA, you have to pay taxes. This is not recommended because the crux of a Roth IRA is to let your money grow tax-free. Also, with a Roth IRA you can pull the money out tax-free. If you set up your withdrawals to come out of your Roth with SEPP, you are effectively paying taxes twice on your money.
- You cannot pull money from a current 401(k) plan. First, you must roll your 401(k) into a traditional IRA. A traditional IRA is the best account to withdraw money from for SEPP.
- If you make a mistake calculating your yearly withdrawal amount, you have to pay a penalty. The penalty can be applied to each year’s withdrawal amount, which could be quite costly.
- You will still be taxed at ordinary income taxes on the withdrawals.

## Do I plan to implement SEPP?

I honestly don’t know. If I was able to go through Vanguard to run the analysis and ensure that I wouldn’t face a penalty, I might be more inclined to consider this approach. However, I am pretty far away from retiring so it is hard to consider implementing this concept.

It appears that you can execute a SEPP almost like a Roth Conversion Latter.

**Implementing this method, SEPP, would have the benefit over the Roth Conversion Latter of not having to wait five years to access your money.**

For example, if you had enough in your Traditional IRA to cover roughly $30k in expenses each year after implementing SEPP, you could essentially withdraw most of that tax-free. That assumes you are married and maybe have a kid or two so that you have enough in deductions to cover the income tax liability you would face.

The caution is – if you are young, you will have to withdraw money until you turn age 59 1/2.

72t has a lot of other provisions as well. We plan on leveraging some of the other ones, Like separating at age 55. But it’s still good to have it as a backup.

Care to elaborate on some of the provisions as well as what you mean by separating at age 55?

The complete list of 72t rules can be found here : https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

See the rule on separation from service at 55. I wrote about this a bit here http://www.fulltimefinance.com/tax-advantaged-accounts/

I tried to let the Mad Fientist know his calculations were off but he blocked my post.

The ladder is the best option because you’ll have more money in tax free when all is said and done.

Plus, the ending figures are off for the Taxable account. Because if the lady is in the 15% bracket in retirement, then she won’t be paying any capital gains on the Taxable account.

Then there is the question of the $9,000 per month. Is that gross of taxes or net? If it’s gross of taxes, then she won’t need to take out as much from the Taxable account, the Roth account, or the ladder. If it’s net of taxes, then she’ll need to take more out of the ladder, SEPP, and Penalty.

The 72t rule is great and can be very helpful to early retirees. Thanks for sharing.

Thanks for the feedback, Andrew. SEPP could be a great way to bridge the 5-year gap you have in a Roth Conversion ladder. However, if you implement SEPP at a young age you will be required to continue withdrawals until age 59 1/2.