By – Ryan Powers
Retiring before age 59½ can create an important planning question: how will you access retirement savings without triggering the 10% additional tax that may apply to early distributions?
As an FMS financial professional, I often remind clients that retirement-account withdrawal decisions are not just about accessing money. The account type, timing of separation from employment, distribution method, taxes and long-term income needs can all matter.
Two options that might come up in an early-retirement conversation are:
The Rule of 55. This may let you avoid the 10% additional tax in certain situations.
Substantially equal periodic payments under Internal Revenue Code Section 72(t), often called SEPP payments. These may also let you avoid the 10% additional tax in certain situations, but they work very differently.
The Rule of 55: Potentially More Flexible Access to a Former Employer Plan
The Rule of 55 may apply when you separate from service during or after the calendar year you turn 55. If eligible, it can allow distributions from that former employer’s qualified retirement plan—such as a 401(k) or 403(b)—without the 10% additional tax.
This rule does not apply to IRAs. That distinction can be especially important for someone considering whether to roll a former employer plan into an IRA before they need access to the funds.
The Rule of 55 may offer more flexibility than a fixed distribution schedule, but eligibility depends on the facts of your situation and the provisions of your employer’s plan. Before making a decision, it is important to confirm what the plan permits and consider how withdrawals may fit into your income needs, tax situation and broader retirement strategy.
72(t) / SEPP: A Structured Withdrawal Approach
A 72(t) strategy uses substantially equal periodic payments, or SEPPs, to create a series of scheduled withdrawals that may qualify for an exception to the 10% additional tax. Unlike the Rule of 55, this approach may be available before age 55 and can be used with IRAs as well as certain qualifying employer-plan accounts.
The trade-off is flexibility. Once a SEPP schedule begins, it generally must continue until the later of five years or age 59½. Changing the amount, stopping payments or otherwise modifying the schedule too soon can lead to retroactive taxes and interest.
That is why we view a 72(t) strategy as a decision that deserves careful coordination. It may help address a specific income need, but it is not a simple way to take occasional withdrawals from an account.
The Most Important Difference: Flexibility
For someone who leaves an employer in or after the year they turn 55 and has an eligible former employer plan, the Rule of 55 may provide greater distribution flexibility.
A 72(t) strategy can offer an alternative for people who need structured access to retirement funds earlier, including those using an IRA. However, it requires a commitment to a prescribed payment schedule.
Neither option eliminates ordinary income taxes that may apply to traditional retirement-account distributions. And neither should be evaluated in isolation from the rest of your retirement-income plan.
Give Each Part of Your Plan a Purpose
Early-retirement withdrawals are one part of a larger income-planning conversation. At FMS, we begin by looking at the income you expect to need, the sources available to you, the amount you may need to keep accessible and the role each account is intended to play.
Our income-planning article explains why retirement income is more than selecting a withdrawal percentage. Your Social Security, pension income, cash reserves, retirement accounts, investments and insurance products may each serve a different purpose.
The same idea is reflected in the FMS ABC Planning Process. By considering cash and liquidity, protected growth and risk growth together, we can help you understand the trade-offs between access, protection and growth potential.
Download the Early-Retirement Withdrawal Guide
Want a simple side-by-side comparison? Download our Rule of 55 vs. 72(t) Early Retirement Withdrawal Guide to review the key differences, eligibility considerations and questions to discuss before taking an early distribution.
Download the Rule of 55 vs. 72(t) Guide
Start the Conversation Before You Leave Work
If early retirement is on your horizon, the time to explore your options is before you separate from service or move assets between accounts. A rollover, distribution or payment election can affect the options available to you.
You can book a meeting with FMS to discuss how your accounts, expected expenses and retirement-income needs may fit together. You may also want to attend one of our upcoming retirement seminars to learn more about the questions that can shape a retirement plan.
Information Only
The information provided in this document is intended for informational purposes only and is not a solicitation to purchase or sell any security.
Securities offered through Packerland Brokerage Services, Inc., an unaffiliated entity Member FINRA & SIPC