December 18, 2018Individual Investment Management

Accessing 401k Funds Early...Normally you aren't allowed to withdraw funds from a 401k or other retirement plan prior to age 59 & 1/2 without a 10% penalty in addition to taxes owed.  There is however, a notable exception to this rule if you are looking for early income.

Meet Rule 72(t): Simply put, IRS Code 72(t), section 2 allows penalty-free access to a 401k before the age of 59 & 1/2.   These withdrawals must occur over the span of 5 years OR until the owner reaches 59 & 1/2 years of age - whichever period is longer.

What you need to know...There are three available methods to meet the rule, but to qualify you must meet the following two criteria regardless of the method you choose:
1.  Equal installments:   Your withdrawals must be in equal amounts.
2.  Subject to life expectancy:   They must be based on your IRS life expectancy table and meet the minimum 5 year requirement listed above.

Do I still pay taxes?...Yes.  Like any other traditional distribution you will pay taxes on the money you withdraw.  Rule 72(t) just helps avoid the 10% penalty and not the taxes owed.

What are the downsides?...When using Rule 72(t), the immediate downside is that you are committing to the following stipulations with regard to your personal finances:

  • Withdrawals are fixed - no exceptions!!
  • You are likely increasing your tax rate in that year.
  • You are drawing down assets that could be invested.
  • You may not be able to replace these assets.

TAKEAWAYS?...Income is a growing concern for many Americans.  While it's not the best answer in every case, Rule 72(t) allows for an individual to take early distributions where it may be necessary.