IRS Rule 72(t) and Rule of 55

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brianh
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Joined: Fri Apr 22, 2016 3:40 pm

IRS Rule 72(t) and Rule of 55

Post by brianh » Fri Apr 22, 2016 4:04 pm

I am over 55 and recently separated from service. Any ideas how I can create Additional Inputs in the Planner or some other way to take early distributions from my last 401k using the "Rule of 55" or IRS Rule 72(t). I'm trying to determine if it's feasible for me to just retire now instead of looking for another job. Until I was separated, I was planning to work about two more years. Thanks.

Brian

jimr
Posts: 483
Joined: Thu Feb 28, 2008 6:48 pm

Re: IRS Rule 72(t) and Rule of 55

Post by jimr » Fri Apr 22, 2016 4:33 pm

Brian,

Thanks for posting. It's an interesting question. I'm not a financial planner and I'm not 100% certain of all the rules for penalty free 401k withdrawals. So I have to leave it to you to verify the IRS requirements.

OTOH, if you are sure you are allowed to take penalty free 401k withdrawals, you could set the 'Min IRA/401K Withdrawal Age' to 55 on the main planner input screen. Doing this will tell the planner not to charge a 10% early withdrawal penalty on withdrawals taken from tax deferred accounts.

By default the planner funds your annual expenses using a fixed withdrawal order. It withdraws from the taxable portfolio until it is depleted, then takes withdrawals from the tax deferred portfolio, then finally from the tax free portfolio. If you plan to fund living expenses in early retirement by taking withdrawals in a different order, you'll need to use additional inputs to account for that.

Please feel free to post followup questions if any part of my answer doesn't make sense.

Jim

brianh
Posts: 2
Joined: Fri Apr 22, 2016 3:40 pm

Re: IRS Rule 72(t) and Rule of 55

Post by brianh » Sat Apr 23, 2016 8:31 am

Thanks Jim.

Under IRS Rule 72(t) you must take substantially equal period payments for at least five full years or until you reach 59 1/2. I know how to set up the payments in the Additional Inputs, but how do you reduce the value of your 401k by that amount each year without the 10% penalty?

Under the Rule of 55 (this applies to me) the problem is you can only withdraw funds penalty free from your most recent 401k. I have three 401k plans but I can only withdraw from one without penalty (the most recent one). Setting the 'Min IRA/401K Withdrawal Age' to 55 doesn't work. The Planner lumps all the Tax Deferred Accounts together.

The closest thing I was able to do was to completely remove the value of the most recent 401k from the Tax Deferred Portfolio Value, and then add a new income row in Additional Inputs with the value of the 401k spread over two years (when I reach 59 1/2). This is kinda rough because it doesn't account for any returns on my investments in that 401k.

Anyone have any other suggestions?

Brian

jimr
Posts: 483
Joined: Thu Feb 28, 2008 6:48 pm

Re: IRS Rule 72(t) and Rule of 55

Post by jimr » Sat Apr 23, 2016 10:15 am

brianh wrote:Under IRS Rule 72(t) you must take substantially equal period payments for at least five full years or until you reach 59 1/2. I know how to set up the payments in the Additional Inputs, but how do you reduce the value of your 401k by that amount each year without the 10% penalty?

Under the Rule of 55 (this applies to me) the problem is you can only withdraw funds penalty free from your most recent 401k. I have three 401k plans but I can only withdraw from one without penalty (the most recent one). Setting the 'Min IRA/401K Withdrawal Age' to 55 doesn't work. The Planner lumps all the Tax Deferred Accounts together.
Perhaps I'm misunderstanding something, but I think the key is whether or not you can structure your withdrawals over the next 4-5 years in such a way as to avoid penalties. The planner isn't designed to help with guidance on exactly which accounts you should withdraw from or which asset classes you should sell from year to year. That level of details is outside of the model's scope.

As long as you're sure you can structure your withdrawals to avoid the penalty, you can set the planner's min penalty age to 55 and not have the planner know/worry about which exact accounts are used to fund the withdrawals. The planner won't assess any early withdrawal penalties and the model should still be valid.

For example, as long as you have enough money in that last employer's 401k, the fact that the planner lumps all your 401ks together should be irrelevant. I would think that computing whether or not you have enough stashed in that one 401k to cover the next 3 or 4 years worth of expenses would be a straightforward calculation. From a practical standpoint, if you go the Rule of 55 route, it might make sense to shuffle assets around so the funds in that last employer's 401k are in less risky investments, while your overall asset allocation stays fixed.

If you don't have enough in that last employer's plan to cover all your expenses for 4 years, then you'll need to make sure your withdrawals are structured so you qualify for the rule 72 exception. Again though, that doesn't sound too difficult to do. The only snag with this approach is that you'll want to keep your expenses level for the first 4-5 years and not have any expense spikes.

rittchard
Posts: 4
Joined: Thu Nov 08, 2018 2:42 pm

Re: IRS Rule 72(t) and Rule of 55

Post by rittchard » Mon Feb 11, 2019 3:52 pm

I'm trying to wrap my head around this stuff too. The way I understand it is the Rule of 55 is independent of the Rule 72(t) or SEPP so I'm basically ignoring Rule of 55 (I'm currently 50).

https://millennialmoney.com/how-to-hack ... l-penalty/

Anyway, presuming the value is calculated independently, is there a way in the Planner to do a fixed withdrawal from the "tax deferred" pool to simulate this? So for example, I'd like to simulate taking out $25,000/yr from a $500,000 IRA for approx. 10 years.

jimr
Posts: 483
Joined: Thu Feb 28, 2008 6:48 pm

Re: IRS Rule 72(t) and Rule of 55

Post by jimr » Mon Feb 11, 2019 4:14 pm

You can set up a negative savings cash flow from the tax deferred portfolio to simulate this, but be aware that this is a pretty advanced usage case that should only be attempted with great care.

When you use a negative savings cash flow, the money just disappears from the portfolio. You'll probably also want to create matching "income" cash flows to represent the net after tax income you'll get after paying taxes on the withdrawal.

If you go this route, I'd suggest looking very carefully at the year-by-year detailed view cash flow results to make sure the planner is doing what you think it's doing.

Jim

rittchard
Posts: 4
Joined: Thu Nov 08, 2018 2:42 pm

Re: IRS Rule 72(t) and Rule of 55

Post by rittchard » Wed Feb 13, 2019 4:23 pm

Thanks Jim!

I think it worked out the way I intended after some adjustments as you mentioned. The ending value of the tax deferred portion was close enough to what's predicted by the SEPP calculator:

https://72t.net/72t/calculator/distributions

For the remainder of my current tax deferred savings, I entered a Tax Deferred Savings for a single year under Additional Inputs. I think this correctly allows that amount to be treated separately from the SEPP pool.

jimr
Posts: 483
Joined: Thu Feb 28, 2008 6:48 pm

Re: IRS Rule 72(t) and Rule of 55

Post by jimr » Wed Feb 13, 2019 4:26 pm

Glad to hear it worked out and thanks for documenting what you've learned here so maybe others can learn too.

Best,

Jim

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