After rolling over my 401(k) into an IRA, I'd like to focus on potentially the single most beneficial reason why everyone should convert their 401(k) into an IRA after they leave their jobs: Rule 72(t).
Rule 72(t) allows for penalty-free withdrawals of your IRA account before the age of 59.5 provided that the IRA holder take at least five “substantially equal periodic payments” (SEPPs). The amount depends on the IRA owner's life expectancy calculated with various IRS-approved methods.
Ideally, you will have built up a large enough taxable investment portfolio to generate enough passive income to pay for retirement. However, if you haven't, then Rule 72(t) serves as a financial bridge for those of you who want to retire early.
Three IRS approved methods to calculate SEPP:
1) Required minimum distribution method: This method takes your current balance and divides it by your single life expectancy or joint life expectancy. Your payment is then recalculated each year with your account balance as of December 31st of the preceding year and your current life expectancy. With this method, your payments will change depending on your account value.
2) Fixed amortization method: This method amortizes your account balance over your single life expectancy, the uniform life expectancy table, or joint life expectancy with your oldest named beneficiary. Such a method is more stable.
3) Fixed annuitization method: This method uses an annuity factor to calculate your SEPP. It's hard enough calculating life expectancy and portfolio performance, let alone forecast interest rates for annuities so let's skip this method.
The most common withdrawal calculation method is #1. I'd like to use my example for how using Rule 72(t) can help an early retiree extract more income and lead a more comfortable financial life.
Utilize Rule 72(t) To Withdraw Money Penalty-Free
Situation: Rolled over my 401(k) of 13 years to a IRA in the spring of 2013.
Estimated IRA value: $400,000.
Investment style: Aggressive, but open to be more conservative if I use Rule 72(t).
View on taxes: Hate them!
During my working years, I was unfortunate enough to pay the top federal income tax brackets of 35-39.6%. Given such a high tax bracket, I gladly maxed out my 401(k) every year to save on taxes.
Because I earned more than $69,000 ($115,000 income limit if married and filing jointly) while working, I wasn't allowed to contribute to a traditional IRA sadly enough. For those of you who have such an opportunity to contribute, don't waste it. Contribute to a Roth IRA.
My last full year of 401(k) contribution was for $17,000 in 2012. At a 35% federal income tax rate, I was able to save $5,950 in federal income taxes in addition to $1,836 (10.8%) in California state income taxes. The total tax savings by maxing out my 401(k) comes out to roughly $7,786.
Today, the maximum 401(k) contribution for employees is $23,500 as of 2025.
Reducing My Tax Bracket In Retirement
Now that I am semi-retired, I've managed to get my Adjusted Gross Income (AGI = income after deductions) down to the 25% tax bracket. If I utilize Rule 72(t) based on a minimum distribution method, I can now withdraw from my converted IRA at a 10% lower tax rate (35% – 25%)!
Based on my 401(k) dashboard where I've run different retirement scenarios, it states that I contributed roughly $200,000 to my 401(k) over 13 years with the remaining $200,000+ coming from match, profit sharing, and investment returns.
To take a conservative approach to tax savings, all I would therefore do is multiply $200,000 in contributions by my tax savings of 10% to equate to $20,000 in less taxes I'll have paid in my 13 year career.
I can also simply take my entire pre-tax retirement fund balance of $400,000 and multiply it by 10% to get $40,000 in tax savings since all of the money may eventually come out.
The bottom line: I'm able to save $20,000 – $40,000 in federal income taxes with Rule 72(t). If I include state income taxes, the savings grows by $6,000 to up to $40,000 if I move to a no income tax state.
Setting Up The IRA For Perpetually Low Taxes
Besides the tremendous tax savings I know I will instantly get if I use Rule 72(t), I can potentially also set myself up for a potential perpetual income stream for eternity, or until the world comes to an end!
Consideration: Change investment goal from aggressive capital appreciation to long term dividend aristocrat stocks for income.
Withdrawal calculation: Based on a single life expectancy of 85, I simply take 85 – current age 35 = 50 and divide my IRA value of $400,000 by 50 to get $8,000 a year in withdrawal. $8,000 a year equates to a 2% withdrawal yield on my entire IRA portfolio. Coincidentally, the dividend yield on the S&P500 is also around 2%.
Various Rule 72(t) Withdrawal And Investment Strategies
Specific strategy #1: If I dump my entire IRA into the S&P 500 ETF SPY or SDY, the S&P500 Dividend ETF, I could theoretically withdraw $8,000 a year for the rest of my life without reducing much if any of the principal! One can conservatively assume that over the course of 50 years, stocks and therefore my IRA and dividend interest will grow at least the pace of inflation.
Specific strategy #2: Instead of investing my entire IRA into the S&P 500 index SPY, I can focus on a smaller portfolio of higher yielding dividend stocks with dividends all above 3%. With a blended dividend yield of around 3.4%, I can now withdraw $13,600 a year at a 25% tax rate without ever drawing down principal.
$8,000 – $13,600 a year in dividend income isn't much, but it's much more than what I thought I would ever receive before the age of 59.5. It's good to know that this is a potentially accessible stream of passive income to add to my passive income portfolio.
Starting Rule 72(t) At An Older Age
Age 35 is admittedly a little early to start withdrawing from an IRA using Rule 72(t) as it will take away from maximum compounding. $400,000 is a nice amount, but as we've seen in the above calculations, the income stream isn't very strong.
Let's use three examples which will help reduce the number of years for withdrawal in order to boost the income stream.
Example #1 Using Rule 72(t) At 35
If I start withdrawing at age 35 with on a 85 single life expectancy estimate, 50 years of withdrawal gives a 2% yield vs. a ~2.2% S&P500 dividend yield. I basically withdraw 100% of what the S&P500 spits out every single year in dividends plus a small 0.2% cushion.
Example #2 Using Rule 72(t) At Age 45
The best age to retire and minimize regrets is age 45. I'm 45 today and believe retiring when I did at 34 was too early.
If I started withdrawing at age 45 with a 85 single life expectancy estimate, 40 years of withdrawal gives a 2.5% yield based on $10,000 a year divided by $400,000. I'm now slightly over the S&P 500 dividend yield and will probably look to buy the highest S&P 500 dividend yielding stocks via the ETF SDY at the very least.
Example #2 Using Rule 72(t) At Age 55
If I start withdrawing at age 55 with a 85 single life expectancy estimate, 30 years of withdrawal gives a 3.3% yield based on $13,333 a year divided by $400,000. This is roughly the maximum I can currently withdraw without spending down the IRA principal.
Example #2 Using Rule 72(t) At Age 45 Again
Let's say I start withdrawing at age 45 with a 95 single life expectancy estimate. This leads back to a 50 year withdrawal level with a 2% yield.
On the one hand, living longer increases the likelihood that a IRA portfolio will last forever. On the other hand, you'll need more money to pay for your life. Hence, it's better to assume you live longer than the median age and build alternative income streams.
New 72(t) Payment Interest Rates
In January 2022, the IRS and Treasury issued Notice 2022-6, which highlights a new rule for determining the interest rate. The new notice enables taxpayers to pick the greater of: 1) up to 5 percent or 2) up to 120 percent of mid-term Applicable Federal Rate (AFR). In the past, the rule had been that 72(t) payments were keyed off 120 percent of the mid-term applicable federal rate (“AFR”).
In other words, this new rule provides a 5 percent interest rate floor for those using the fixed amortization method and the fixed annuitization method to compute a 72(t) payment. A 5% interest rate is relatively high in this low interest rate environment. Even though the 10-year bond yield has risen from a low of ~0.5% in 2020 to 2% today, it is still much lower than 5%.
In other words, the new Notice 2022-6 rule enables early retirees to withdraw more money penalty-free prior to age 59.5. An early retiree can select an interest rate anywhere between 0% to 5%.
Think Carefully Before Using Rule 72(t) For Retirement
I've always mentally written off my 401(k), which is now an IRA because I never wanted to depend on government sponsored pre-tax programs to survive in retirement. The same thing goes for social security. This is the reason why I've aggressively saved more than 50% of my after tax income every year I worked.
If all I had was my 401(k)/IRA in retirement and no other savings or income streams, I'd be screwed because I never planned on working for 37.5 consecutive years after college. I knew after two years on Wall Street that I wanted to retire by 40.
With Rule 72(t), I can now conservatively utilize all my years of pre-tax savings at a 10% lower tax rate to enjoy now. If I maintain a 2% withdrawal rate or less, I should be able to receive $8,000 a year for the rest of my life and potentially pass on the principal to a loved one.
Do The Math For Ideal Retirement Income
The issue I have is that $400,000 just isn't a significant enough amount of money for me to enact Rule 72(t). I've got enough passive income to pay for all expenses and then some. Instead, I would like to try and grow the $400,000 into $1 or $2 million dollars over the next 10 years and then start withdrawing at age 45 or thereabouts.
To grow your portfolio, it's clearly better to reinvest the dividends into the markets. However, if you are retired, need the income, or don't plan to live for a long time, utilizing Rule 72(t) is a no brainer.
The purpose for all those years of saving for retirement is to actually spend the money in retirement. From a financial standpoint, I can't think of much worse things than saving for decades only to die without being able to spend your hard earned money.
Always try and take full advantage of all your tax-advantaged accounts. I'm thankful to not have withdrawn funds using Rule 72(t) because my rollover IRA is now worth almost $1.4 million. The longer you can get your investments to compound, the better.
What retirees do need to realize is that their rollover IRA and 401(k)s are considered big pots of deferred income. Required Minimum Distributions will force retirees to withdraw funds after age 72. As a result, retirees could pay more income taxes when retired.
To diversify your tax liability, consider conducting a Mega Backdoor Roth IRA and pay some taxes up front. This way, you're hedged in the future.
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Achieve Financial Freedom Through Real Estate
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About the Author
Sam began investing his own money ever since he opened an online brokerage account online in 1995. Sam loved investing so much that he decided to make a career out of investing by spending the next 13 years after college working at Goldman Sachs and Credit Suisse Group. During this time, Sam received his MBA from UC Berkeley with a focus on finance and real estate. He also became Series 7 and Series 63 registered.
In 2012, Sam was able to leave his day job at age 34 largely due to his investments that now generate roughly $380,000 a year in passive income. Private real estate investments are his main focus today. He spends time playing tennis, hanging out with family, consulting for leading fintech companies, and writing online to help others achieve financial freedom.
This article contains references to products and services from one or more of our advertisers. Fundrise is a sponsor of Financial Samurai and Financial Samurai is an investor in Fundrise. When you sign up through links on our site, we may earn a commission at no additional cost to you. Thanks for your readership and support.
You can also use the rule with a 401k and there are several reasons why you might want to do that. It has to be a 401k left at a former employer, can’t be active. That said, many 401k plans, especially at very large companies, have access to some special funds such as Stable Value.
Could you update this article with the new IRS interest rate rule change? It’s a game changer to choose a 5% interest rate.
Updated, thanks! Hopefully, nobody needs to withdraw early though because they’ve built up passive investment income sources. However, anybody coming to this article through search has such an intention of withdrawing early from their tax-advantaged accounts.
I just wouldn’t. Let it compound for as long as possible.
Sir I just found your blog, wonderful content!
I just retired from the federal government and have a modest 401K – (300K). Unfortunately my pension drops from 110K while working down to 35K in retirement. It will be a challenge to pay my mortgage and other mandatory expenses with just my pension. I truly did not want to withdraw my 401K for all the reasons you point out. At this point I’m a paralysis of analysis trying to figure out a solution. The rule 72(t) may be such a solution but I’m unsure. My goal is to sell my home next June when my Son graduates and downsize. Secondarily I want to continue to grow my nut for the future. Any guidance from you is greatly appreciated
Semper Fidelis
Ken
Im 55 years old and not working for the last 4 years, waiting to be aproved for ssdi benefits. work for 31 years for the same company, i have about 700k in a 401 , im runing out of my savings and would like to know if i can move my 401k to a roth ira and start collecting 72(T) payments to help with bills. i need around 35k to 40k yearly to cover all our payments. is this possible. thanks
One thing to consider is that if you decide to emigrate to another country (such as Australia) many of them will consider a 401k as a legitimate savings vehicle and will not tax you twice on it (tax you again after you have paid tax on it in the US) or tax you on capital gains but if you roll over into an IRA this will be taxed. A small caveat that probably won’t be of consideration to most people
hi, im 54 and ou tof work since 2012, trying to get aproved by ssdi, still waiting for the decision. I do have a good chunk in 401k, but not contributing since 2012 , now that we need help with finances on a monthly basis, were can i turn for help.
i need about 4k monthly to cover bills.
We are in a tight financial bind with a job loss and car that needs to be replaced. If I pull $18,000.00 from my traditional IRA in order to buy a car, how could this rule apply for me?
Do you know what other ramifications I could face and how much?
Another reason to roll your 401k into an IRA: most 401k plans have limited options if the owner dies. Some will just cash out to your heirs.
An IRA can be set up as an inherited IRA where the beneficiary draws a RMD based on their age. The balance continues to grow tax deferred.
If I started a 72(t) April 2013 and have received installments since then, I turned 59.5 in June 2015, Can I continue to receive installments from the 72(t) and also draw a lump sum from my IRA without penalty?
thanks,
[…] Use Rule 72(t) To Withdraw Money Penalty Free From An IRA […]
I thought you could use the SEPP rule on your 401k as well. Then you wouldn’t have to convert to an IRA and pay the higher taxes while still working. Am I wrong about this?
FS, excellent piece. If I understand correctly, you’re counting on a mutual fund to throw off blended dividends of 2-3%. But those stocks could dive and bringing your principle down.
Why not purchase a reasonably safe long-term corporate bond paying 3 – 4% and hold until maturity? (Fidelity Corporate Notes program offers these every week as new issue at par from a small selection of decent companies.) This week I purchased a 10-year Morgan Stanley bond at par paying a fixed 3.2%
Or, why not purchase a long-term CD (of course, not at today’s rates but if rates are acceptable when you’re ready)?
I had never heard of Rule 72(t), guess you learn something new every day.
In your position I don’t think I’d tap those funds just yet. Ideally I’d let the “retirement” accounts compound and grow as long as possible and live off of savings and other streams of income until it was absolutely necessary to start drawing on your IRAs.
I agree, which is why I’m hoping to grow the 400K into $1 or $2 million in the next 10 years, or blow up trying!
That is certainly a compelling reason but consider this. Many 401k’s will let you withdraw penalty free at the age of 55. I’ve always favored rolling funds into an IRA but the 55 exception actually prompted me to keep my funds from my last employer in the 401 k it was in. I’m happy with the investment options there and am in my early 50’s so it makes sense for me. I guess it really depends on your age and when you think you’ll need the funds!
Yep, good to have the age 55 option as well. It’s good to know those with IRAs have an even greater flexible option too. If you’re happy with your funds, great!
Sam,
Your inclusion of AT&T for dividend got my attention. The yield is actually at 4.8% currently. Looking over their balance sheet, I don’t see how this is sustainable. Can you elaborate on why you think it may be? To me it looks like they are spending issuing a dividend they don’t have the money for. Thanks. I really enjoy your blog.
I included AT&T after doing a screen of the top dividend yielding stocks. A dividend yield changes by the day as it depends on the stock price. Going into the dividend payout strategy of AT&T is beyond the scope of this post, and I do not know.
Sam,
Let it compound, grow the nut large enough. Then buy a triplex, take an interest only mortgage against the property through a cash out refinance. Make the payment large enough where you will use 401K money to pay part of it. Take out enough to cover part of the mortgage, using the interest income as a write off. The rental income is offset with depreciation, you have legally taken out money while pay no tax. Live off and invest the cash out refinance and the rental income while paying no taxes on that money. Rinse and repeat with another property.
When I get motivated again I will write how the numbers would work, this would work especially well here in Hawaii with the high land prices and the fact you can get $5000+ on a triplex in the right neighborhood
Sounds like a lot of work. I look forward to your post!
What is “large enough” in your opinion?
Ideally $1 million in 401K and a rental property with a low cost basis due to utilizing depreciation. (Paid down by renters over the years.) Do a 1031 exchange into the triplex, financed with a cash out to unlock the equity.
Seems like a lot of work but could mean tens of thousands in saved taxes.
Well I learned something new today! I was totally unfamiliar with Rule 72(t)! Hope I don’t need it, but nice to know it is there.
Excellent article, and as you said, thanks to JayCeezy and MrsPops for pushing the 72t rule on you (probably multiple times)!
And as always, thank you for the articles that you write.
Thanks for the information I think a small correction is due
Acorordinr the the IRS , you will need to make withdrawls for 5 fivers or until you turn 59 1/2
When do I fulfill my obligation to take substantially equal periodic payments?
The substantially equal period payments must generally continue for at least five full years, or if later, until age 59 ½. For example, if you began taking payments at age 56 on December 1, 2006, you may not take a different distribution or alter the amount of the payment until December 1, 2011, even though your fifth payment was taken on December 1, 2010.
If you begin taking substantially equal periodic payments on December 1, 2005, and you turn 59 ½ on July 1, 2011, you may not take a different distribution or alter the amount of the payment until July 1, 2011.
Although this is available, you may not want to take advantage of it. Most of the growth occurs in the 30-40 year time frame.
Agree. This is a fall back option and an additional financial buffer. I really like the idea of creating a perpetual income stream that doesn’t draw down principal.
This is very timely for me. I’m 50 and considering retirement. My husband is older, already retired and we have determined we can live on his pension/SS/401(k) and should not have to touch mine for a while. Only concern is IF something was to happen to him before I turn 59.5. (my access to his pension and SS would be cut in 1/2). Knowing that I have the 72(t) to fall back on makes the decision so much easier! Anyone have any additional input? I would love to hear it.
I do not think your ss would be 1/2 – I think it would be 100% of what he gets, if he died. You would get 1/2 of his amount while he is alive – unless your ss benefit is higher than this – which it likely would be.
I think David is right. It would be unreasonable to assume you would get only half before you turn 59.5. I think you get 100% of what he would have got once you turn 59.5.
Your attitude on Rule 72(t) is exactly what makes me happy. It’s something I can fall back on, AND pay lower taxes in my case in case I really need the money, penalty-free.
Thanks for the shout out, Sam!
We’re definitely considering using the 72(t) as a portion of funding early retirement, and have fiddled with the idea of turning it on at 35 or 40 with varying results. One of the reasons we’re pretty okay with this idea is that though we’d be giving up some of the compounding, the required distributions would still be small enough that a reasonably aggressive portfolio would outperform it. We’ve also got our Roth IRAs which so far we plan on leaving untouched until 59.5+.
The other thing to keep in mind is that by rolling over into an IRA, even if you don’t take 72(t), most people will come out ahead because of limited investment options that often come with higher fees in their 401Ks. Even if we don’t end up using 72(t), as soon as we stop working for our companies, we’ll be rolling over into a Vanguard IRA where we can get similar funds and investment objectives with significantly lower fees.
The lower fees is indeed a blessing, although the 401(k) has been under so much scrutiny now that I’m sure these fees will come down over time.
I’m just excited about the flexibility to invest in other securities such as these Chinese stocks I mentioned in a previous post. We’ll see what happens!
For those finding the subject of interest, here is a website with some remarkable calculators. https://72t.net/ Click on the ‘Calculators’ tab, fill out the data, then go back to the top and click on the Blue “Calculate” bar at the top of the data (easy to miss). You can get an idea very quickly of what you can withdraw, do “what-if” scenarios involving a spouse or inheritor, and possible penalties.
A great book that utilizes 72(t) in a Retirement Drawdown scenario is “Buckets of Money” by Ray Lucia. In a nutshell, the main goal is cashflow; minimizing taxes is part of maximizing cashflow. In example, if you retire and are in the 15% bracket while drawing down savings that have already been taxed for living expenses, it does not make sense to avoid taxes now if the untaxed savings will later be drawn down in the 33% bracket, and cause 85% of your Social Security to be taxed. FS, this is a good problem to have for you.
Thanks for the heads up! Will check out the calculator and incorporate it in the post.
I hope by the time I’m in max withdrawal mode, I’ve set up residency in one of the no income tax states.
I am someone who only does a minimum to meet company match in my 401k, and I am going to try to max out my andmy wife’s RothIRA first. I currently make 71k per year pre tax, and am still in the 15% bracket. Once my wife can find a teaching job that would push our combined income into the 25% bracket, we will shift that portion taxed at 25% into my 401k.
Right now we are focusing on paying off her 30k of student loan debt before we really push the retirement envelope. I would love to get a larger overall portion of our salary into savings/retirement. I know that compared to a lot of people in my area, I do make a “lot of money”, but in the grand scheme of things I know it is a drop in the bucket. Net worth is sitting about 95k right now factoring in the house.
Once she finds a steady teaching job, we will be able to use her entire income toward saving and investing.
15% really is an agreeable tax bracket, hence I don’t think contributing all you can to a ROTH IRA now is a bad idea.
Given it seems like you are just getting started on your journey, I think you will find this post on net worth allocation recommendation helpful. https://www.financialsamurai.com/2013/02/11/recommended-net-worth-allocation-mix-by-age-and-work-experience/
Save as much as you UNCOMFORTABLY can! It will pay off in the long run.
I would avoid withdrawing at all cost, but that’s just me. If you need money now while you are young, chances are you’ll need more when you’re older. It’s a bad idea to draw down in you 30s or 40s unless you have a mother load of an IRA.
Good point. Rule 72(t) is not something I encourage very early on. It’s just nice to know it’s there if needed, and can be implemented to save on taxes depending on your work time tax bracket. Let it compound!