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144 MG Use a 72(t) Plan to Avoid the Early Withdrawal Penalty

Find out about a little-known retirement account tax rule.Like what you hear? Help us out by writing a review at iTunes. Questions go to money@qdnow.com. Thank you!

Broadcast on:
07 Oct 2009
Audio Format:
other

Find out about a little-known retirement account tax rule.Like what you hear? Help us out by writing a review at iTunes. Questions go to money@qdnow.com. Thank you!

Hey, Spotifyers. Ever wondered how to save for retirement? Advocate for yourself in the workplace? Pay down debt. Women Talk Money is here to answer all your money questions. Click or tap the banner to join the community today. Brought to you by Fidelity's Women Talk Money. After investing billions to light up our network, T-Mobile is America's largest 5G network. Plus, right now, you can switch, keep your phone, and we'll pay it off up to $800. See how you can save on every plan versus Verizon AT&T at tmobile.com/keepandswitch. Up to four lines via virtual prepaid card, a left 15 days qualifying unlock device, credit, service, port, and 90-plus days with device and eligible carrier and timely redemption required. Card has no cash access and expires in six months. Hello, and welcome to Money Girls' Quick and Dirty Tips for a richer life. (doorbell rings) I'm your host, Laura Adams. In this episode, I'll discuss a legal way to make early withdrawals from your retirement account without having to pay an early withdrawal penalty. When it comes to saving for retirement, you can't beat government-sponsored retirement accounts. If you're a regular Money Girl listener, you already know about the great tax advantages you receive for keeping your money in a retirement account until you're 59 and a half years old. But what happens if you need to get your money out of a retirement account before you retire? Early withdrawals are usually not a good idea because there's a steep 10% penalty to pay, except in certain qualified situations, such as distributions for first-time home buyers, education expenses, and medical hardships. However, there's a little known legal loophole that you can use to avoid the early withdrawal penalty. Before you consider this option, realize that it comes with restrictions and risky consequences. The loophole for early withdrawals that I'm talking about is called a 72T payment plan. The name comes from its numbered section of the IRS tax code. 72Ts are also known as substantially equal periodic payments and they can generally be used with retirement accounts such as IRAs, 401Ks, and 403Bs. Here's how 72 payments work. You can set up a plan to take equal monthly or annual distributions out of your retirement account. The amount of money you can take out is calculated using an accounting method that's approved by the IRS. The payment amount depends on various factors such as your retirement account balance, age, life expectancy, as well as the age and life expectancy of your account beneficiary. I'll put a link to a 72T calculator in the show notes at moneygirl.quickanddirtytips.com that shows how much you could receive in distributions based on your situation. Once you begin taking 72T distributions from a retirement account, you must continue taking them for a minimum of five years or until you turn 59 and a half, whichever is longer. During that time, you generally can't modify the payment amount or suspend the payments. After you've completed a series of 72T payments and reach the age of 59 and a half, you can take retirement distributions out of your account as you see fit. However, for most traditional retirement plans, once you reach age 70 and a half, you generally must take required minimum distributions annually from your retirement account, whether you used a 72T plan or not. Another restriction of having a 72T plan is that you can't make additional contributions to the retirement account while you're receiving periodic payments. 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In these challenging economic times and increasing number of retirement account owners have been using 72-T payment plans to tap their money without incurring an early withdrawal penalty. If you're facing a devastating financial hardship or bankruptcy, draining your retirement funds prematurely may be your last resort to pay for day-to-day living expenses. Or if you're fortunate enough to retire early, you can use a 72-T plan to start spending your retirement stash. If you're certain that you have enough retirement money to last as long as you'll need it, you can use 72-T distributions to pay down or eliminate debt, pay for college tuition for family members or to supplement your current income. Here's an example. Let's say Alex has accumulated a large nest egg well ahead of his retirement saving schedule. He decides to retire early and sets up a 72-T plan for his IRA when he's 50 years old. The rule is that he must continue taking substantially equal periodic payments for five years or until he's 59 and 1/2, whichever is longer. Since he's 50, he can't stop taking the 72-T distributions for 9 and 1/2 years until his 59 and 1/2 birthday. Here's another example. Sue gets downsized from her job and is offered an early retirement settlement from her company at age 58. She rolls over her 403(b) into an IRA and sets up a 72-T plan. Even though she only has a year and 1/2 until she reaches the official retirement age of 59 and 1/2, she has to continue taking the 72-T payments for five years until she's 63. At that time, she can continue taking the same distribution payment or modify it to any amount that she wants. An important point to remember is that 72-T payments are subject to regular income tax unless they were already taxed, as would be the case for contributions made to a Roth account. When a 72-T plan is executed properly, it can be a smart way to access your retirement funds early. But when it's set up incorrectly with a botched payout schedule, for instance, it could result in expensive consequences. Therefore, it's important to set up a 72-T payment plan only if it's absolutely necessary. Never enter into a 72-T plan lightly or count on it to bail you out of a financial mess. The IRS rules and payment calculations for these plans are complicated even for professionals. So if you're interested in setting up a 72-T, be sure to consult with a competent financial advisor or accountant who has specialized experience handling them. The QDT network wants to know more about you. Please give me a few minutes of your time and take the listener survey in the Money Girls section at quickanddirtytense.com. I know surveys can be boring, but I actually found this one interesting. I'm glad you're listening. Cha-ching. 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