There are a number of ways to get money out of an IRA before you are 59 and a half years old. One is a Roth Conversion, but the problem with that is you have to pay tax and potentially a penalty. The only other way is something called a 72(t).
The 72(t) basically means separate equal periodic payments. What this means is that you can take money out of your IRA before your 59 and a half years old as long as you do it in separate equal yearly distributions that last for at least five years, or until you are 59 and a half, whichever is longer.
With the 72(t) you can take out about 5%, but that number ebbs and flows with interest rates.
The IRS gives you three different income options when it comes to the 72(t). The first two options are fairly similar, amortization and annuitization. The third option is the required minimum distribution method.
The RMD method is different because it’s recalculated every year, and is designed to get bigger each year. With the first two methods, you are locking in to a level payment.
If you don’t keep the payment for a minimum of five years, you are going to pay a penalty. The only way to waive the penalty is to die or become disabled, but you do have a chance to change the method once if you see an issue in the future.
The number one reason to do a 72(t) is to fund an LIRP and there is no other money anywhere with which to do so. Number two is you can’t do a Roth Conversion because you have no money in your taxable bucket. Number three is to stymie the growth of an IRA prior to the 59 and a half year mark.
Only one of ten will be a candidate for the 72(t), but for those who can take advantage of it, it can be a powerful tool to get money flowing to your tax-free bucket.
Beyond funding an LIRP, you can spend the money however you want. David recommends putting the money into a tax free account. The point is to start growing dollars in the tax free bucket.
Letting the tax deferred bucket grow in an uncontrolled way complicates your tax picture down the road, especially in a rising tax rate environment.
You can be too young to use a 72(t) since you are committing to a lengthy time and your situation may change. There are also older ages where the 72(t) doesn’t make sense. The closer to 59 and a half years old you are, you may as well wait instead of getting locked in and risking a penalty.
The 72(t) should only really be used when there are no other options to fund the Roth Conversion or the LIRP, and the ages between 50 and 57 is the sweet spot for it. It’s a great concept that allows you to start getting money into the tax free bucket, but it should only really be used in prescribed scenarios.