Strategies For Maximizing (Or Minimizing!) Rule 72(t) Early Distribution Payments Using IRS Notice 2022-6

Strategies For Maximizing (Or Minimizing!) Rule 72(t) Early Distribution Payments Using IRS Notice 2022-6

Sometimes there are situations where individuals need access to funds in their tax-deferred retirement accounts sooner than the rules say they can. In fact, except for a narrow range of ‘emergency’ situations, the only way most individuals can access these funds without incurring a 10% early withdrawal penalty tax is by setting up a “Series of Substantially Equal Payments”, otherwise known as 72(t) payments.

Until recently, however, the interest rates used to calculate the amounts of 72(t) payments have been so low that the payments themselves often weren’t enough to meet the needs of individuals who wanted to access their retirement funds. But, with the recent release of IRS Notice 2022-6, the potential amount of 72(t) payments many individuals can make has been substantially increased. Which means that 72(t) payments might now be a more realistic option for individuals who need early access to their retirement funds!

For those who wish to receive 72(t) payments, there are several rules which must be considered. First, those receiving 72(t) payments must take recurring annual distributions for either 5 years or until reaching age 59 ½ – whichever is longer. Second, taxpayers must use one of three methods established by the IRS to calculate their 72(t) payments: RMD, amortization, or annuitization. Regardless of which method is used to calculate payment, the price for altering or canceling a 72(t) payment is steep, usually resulting in a 10% penalty tax on all distributions previously taken – plus interest!

However, IRS Notice 2022-6 sets a new ‘floor’ interest rate of 5% for calculating 72(t) payments, representing a substantial increase over the previous maximum of 120% of the applicable Federal mid-term rate. Thus, for a 50-year-old with a $1 million retirement portfolio, this means the maximum annual 72(t) payment increases from about $37,000 to over $63,000! The scale of the change is significant enough that some individuals may now need to consider ways to reduce their 72(t) payments if they are more than they need to withdraw. For example, someone can consider splitting their retirement accounts into two separate accounts, such that 72(t) payments are only taken from one account, and accessing funds from the other (non-72(t)) account won’t risk creating a modification of their 72(t) payment schedule (and triggering the associated penalties and interest).

Likewise, for those using the annuitization or amortization methods and who may no longer need as much from their 72(t) payments (but who continue receiving them to avoid retroactive penalties and interest), the rules allow for a one-time change to the RMD method of calculation (which generally results in lower maximum payments than either the amortization or the annuitization method) without creating a modification to the schedule. Which can at least reduce taxable income (and the amount drawn from retirement funds) that an individual in these circumstances may not need.

Ultimately, the key point is that with the updates made by IRS Notice 2022-6, 72(t) payments may now be a more practical option for individuals who need early access to retirement funds. Which can give advisors and clients a reason to reconsider this strategy with fresh eyes – either to alter an existing schedule, or perhaps to establish one for the first time!

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