Marketwatch, April 28th, 2010
For many older workers the recession has been
especially tough. Salaries and benefits have been cut, insurance costs
have risen. That slimmer paycheck isn’t going as far as it once did.
But there is one little known, if troublesome, way that some older
workers might be able to make up some of the shortfall: You can tap into
your nest egg a bit early.
The law dictating when you can use your retirement money is
straightforward: Funds withdrawn from an individual retirement account
before age 59 1/2 are subject to a 10% hit. But the Internal Revenue
Service permits a loophole, part of Section 72(t) of the federal tax
code, where the penalty does not apply if the money is paid out in set
amounts over time.
Be careful. Using this exemption isn’t so straightforward — it does
reduce savings you will need for many years to come.
To qualify, you must take what the IRS calls a series of “substantially
equal periodic payments,” or SEPP, from your traditional IRA. (Roth IRA
withdrawals aren’t penalized.)
This is where the simple part ends.
No one-time payouts
“Periodic payments” means taking installments at least annually for a
minimum of five years or until age 59 1/2, whichever is longer. So if
you’re 50 years old, the SEPP will be in effect for almost a decade
before you can stop. Someone who is 57 years old will be bound to the
plan until age 62, well past the time when the 10% penalty would no
longer have applied.
“Substantially equal” means the periodic payments must adhere to one of
three formulas: a required minimum distribution method; an amortization
method, or the annuitization method.
What’s the difference? The size of the payments can be substantial.
Minimum distribution gives the lowest payment but fluctuates with the
value of your account, whereas the other two options supply higher,
fixed, payments.
These calculations are based on savings, age, life expectancy and a
government-supplied “reasonable” interest rate. You don’t have to do the
math — many financial-planning Web sites have handy 72(t) calculators.
Check out Bankrate.com or, for a comprehensive guide, go to 72t on the
Net (72t.net).
Editor’s Note: No link this time, just a careful warning. While this article does describe accurately the mechanics, upsides, and downsides to performing this type of operation, it is fraught with danger. The very concept of drawing upon retirement savings to fund existing costs, even necessary ones, places many people in the gravest of trouble. Unless there is a desperate need, even if you fully intend to pay the money back, NewRetirement strongly encourages would-be retirees to very very carefully consider this course of action, no matter how sure or necessary it may appear.
