The Risks of 72 (t) Early IRA Withdrawals

Did your broker recommend taking money from your retirement account using Section 72 (t) of the Internal Revenue Code?

(FeedPublish) Some financial advisors encourage their clients to use 72(t) as a means of taking early retirement.  To understand why a financial advisor may instruct someone to take advantage of this high-risk rule, we must first understand how retirement accounts work.

72(t) has the potential, if done wrong, to cost a hefty sum in penalties and fees, making you wish you would have just waited to start withdrawing from your IRA at retirement age.

An Individual Retirement Account (IRA) is an account that allows you to save for retirement either with after-tax earnings or on a tax-deferred basis. Different IRAs offer different tax benefits for your overall savings.  With a Traditional IRA, you invest your earnings in a tax-deferred account until you are ready to withdraw them in retirement.

On the other hand, a Roth IRA allows you to invest the earnings you have already paid taxes on.  This money may then grow tax-free, with tax-free withdrawals in retirement.  Whether you choose a Traditional or Roth IRA, their tax benefits allow your savings to potentially grow or compound more quickly than in a taxable account.

If you take your money out of your IRA before turning 59.5, you have to pay a 10% early withdrawal penalty.  The exception to the rule is to take 72(t) or substantially equal periodic payments.  Through 72(t), the Internal Revenue Code permits distributions prior to age 59.5 based on one of three IRS-approved life expectancy calculations.  This means that you must continue to take funds from your IRA for 5 years or until you reach age 59.5, whichever comes later.  For example, if you start taking your payments at the age of 52, then you must do so for 8 years.  Someone who starts at 57 must do so till the age of 62.  Once you have withdrawn payments for 5 years and you have reached age 59.5, you may discontinue the payments.

The 72(t) exception may sound like a perfect solution if you don’t want to wait until you are 59.5 to retire; however, it has its drawbacks.  First of all, the periodic payments you are required to withdraw are still taxed at your income rate.

Secondly, once 72(t) payments start, they cannot be stopped or modified for any reason.  If payments are modified other than due to the death or disability of the IRA owner, a 10% federal income tax penalty plus interest will be retroactively applied to the payments beginning with the first year of your distributions.  This means that if you are in year 4 of taking 72(t) payments and you violate the guidelines, you will have to pay a 10% tax penalty and interest on the entire amount you have withdrawn over the first 3 years and not just on the amount you violated in year 4.  This retroactive penalty can be disastrous for individuals already in a tough financial position.

Did your advisor recommend Early Withdrawal in your IRA?

Even with these risks, some financial advisors recommend 72(t) to clients who want to take retirement early.  This can be bad advice. If you begin withdrawing interest funds from your IRA when the market is doing well, and then the market suddenly experiences a downturn, you are now stuck withdrawing at your initial rate.

These forced withdrawals could cause you to wipe out your interest, whittle away at your principal, and ultimately deplete your retirement fund.  You may also be forced to sell your investments in order to generate cash to get your payments out.  Meanwhile, this activity often generates high fees and commissions for your financial advisor, reducing your account even further.

Remember, your IRA is your nest egg. It’s a long-term investment in your future, and it should be treated as such.  While unforeseen circumstances happen in life, 72(t) should not be your only option in addressing your financial concerns or desire to retire early.

For more information, see:

Is a 72t Early Retirement right for you?

If you believe your financial advisor took advantage of you by recommending a 72(t) and you suffered financial losses, please call The White Law Group at (888) 637-5510 for a free consultation.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm dedicated to the representation of investors in FINRA arbitration claims against brokerage firms throughout the United States.

For more information about The White Law Group, please visit www.WhiteSecuritiesLaw.com.