IRS regulation 72(t) on withdrawals and penalties and its significance

The term 72(t) originates from a section of the Internal Revenue Code, as you might have thought. It discusses equal recurring payments and how to use them in Individual Retirement Arrangements (IRAs) and employer-sponsored defined contribution plans (such as the Thrift Savings Plan) to avoid the 10% early withdrawal penalty.

Any post-separation withdrawals from the TSP made the year before you turn 55 will be subject to a 10% early withdrawal penalty. The minimum age is 50, not 55, for some special category personnel, including law enforcement officers, firefighters, CBPOs, air traffic controllers, Capitol and Supreme Court police officers, nuclear material couriers, and DSS special agents in the Department of State.

No matter your employment status, the penalty also applies to any IRA withdrawals made before you turn 59½ (not the year you turn 59½, but the day you turn 59½).

If you adhere to rule 72(t) and receive equal regular payments for five years or up until you reach the age of 59½ years, you are immune from the 10% early withdrawal penalty.

To avoid the early withdrawal penalty on TSP withdrawals, a regular employee could leave the federal government under a VERA at 53 by abiding by Rule 72(t) and waiting until they were 59½ years old.

The Thrift Savings Plan (TSP) offers a withdrawal option called “installment payments” that follows the IRS life expectancy table created explicitly for this kind of person. An individual effectively elects substantially equal recurring payments by selecting that withdrawal option, and they will not be penalized. Whether they choose monthly, quarterly, or yearly installment payments doesn’t matter.

However, if the person mentioned above were to deviate from this withdrawal option, either by switching to paying a fixed amount in installments or by taking a second partial withdrawal (which is now permitted as a result of the TSP Modernization Act), they would end up owing early withdrawal penalties going all the way back to the beginning of their withdrawals.

You must follow it strictly if you plan to employ 72(t) to avoid the early withdrawal penalty. Coordinate your payments with the IRA custodian if you’re thinking of withdrawing regularly scheduled installments from an IRA that are roughly similar in amount.

A life expectancy-based withdrawal makes sense for retirees aged 72 or older who are obligated to take minimum distributions (RMDs) from their IRAs and the TSP (50% of the missed RMD is the fine for missing an RMD). Your penalty would be $1,500 (or half of the $3,000 you would have taken but didn’t) if you were obligated to withdraw $12,000 yearly but only withdrew $9,000 instead.

You will withdraw exactly the appropriate amount and won’t be charged a penalty of 50% if your IRA custodian arranges for substantially equal recurring installments. You will always be protected from the penalty by the TSP’s guidelines.

The TSP will give you an additional payment of the amount required to meet your RMD if, after your final payment of the year, you haven’t taken out the complete amount of your RMD.

However, there’s still more! If you’re receiving payments from the TSP based on a life expectancy chart, there is one more item you need to be aware of. The infamous “tax trap” of the TSP.

Although withdrawals from your standard TSP are fully taxable at your usual income tax rate, the TSP has the following policies regarding withholding from payments based on life expectancy. Unless you choose a different option, you must withhold federal taxes from any taxable amount as though you are married with three dependents.

This withholding rate is insufficient to satisfy the taxes due on your TSP payments. You can get a nasty surprise about taxes if you don’t choose a different withholding rate.

Reasons to Apply Rule 72(t)

The 72(t) rule allows early access to retirement savings that a person would not usually be permitted to use unless they meet the required exclusions. There is additional flexibility to dip into retirement money you otherwise wouldn’t be able to access when unforeseen financial condition changes occur. But these withdrawals have stringent conditions, and breaking them will have costly repercussions.

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Bio:
Rick Viader is a Federal Retirement Consultant that uses proven strategies to help federal employees achieve their financial goals and make sure they receive all the benefits they worked so hard to achieve.

In helping federal employees, Rick has seen the need to offer retirement plan coaching where Human Resources departments either could not or were not able to assist. For almost 14 years, Rick has specialized in using federal government benefits and retirement systems to maximize retirement incomes.

His goals are to guide federal employees to achieve their financial goals while maximizing their retirement incomes.