If you know about a little secret buried deep in the IRS code… you can use the money you’ve saved in your IRA, 401(k) or TSP accounts, no matter what your age, completely penalty free. This might come in handy in this economic environment.
Most people think you’ve got to wait until age 59½ to start taking money out of your IRA, 401(k) or TSP accounts without paying a 10% penalty. But the truth is: You can take out your savings at any age you wish, even if you are in your 30s or 40s, without paying a penalty… thanks to Section 72(t).
Of course, you have to remember any money you use now won’t be there when you retire. But if you need the money, it’s better to get it out without the penalty.
There is another reason to use rule 72(t). As discussed in earlier articles, you may want to move your money out of your 401(k) or IRA so that you diversify your tax risk i.e., pay the tax now instead of later when tax rates may be higher. Given the way the deficit is looking I am afraid taxes will be much higher in the future. By paying the tax now you reduce your tax risk that more of your money will be taken in taxes.
A Forbes article shows how a chiropractor, Alfonse DeMaria, took $700,000 in his IRA and converted it to a $3,000-a-month income stream. He bought himself a six-bedroom home with 269 acres in rural New York to enjoy with his family. “My kids and I can start enjoying the house now rather than 25 years from now, and it will still be here then, too,” he said.
Here’s the deal:
- Unfortunately, you can’t take the money out in a lump sum
- You must take the same (an equal) amount on a monthly or annual basis
- You have to take this amount out until you are 59 ½ or a minimum of 5 years
- How much you can take out is based on three calculations the IRS lets you use. Each method comes up with a different amount so you need to evaluate the methods carefully.
Since there is no Santa Clause you have to pay regular income tax on any amounts you withdraw. You will eventually have to pay taxes on the amounts in your retirement accounts no matter when you take it out. Keep in mind you did not pay tax on the amounts or earnings in your retirement account. So you have to pay the piper when you take the money out. Rule 72(t) lets you avoid the 10% penalty, which is added in addition to any income tax on the amounts withdrawn if you don’t use this rule.
Since rule 72(t) will impact your retirement account until you are a least 59 ½ you need to plan carefully before implementing this strategy. Since there are a lot of variables I wouldn’t try this at home without professional help.