What You Need to Know to Retire Early

Physician's Money Digest, June30 2003, Volume 10, Issue 12

For those of you who have considered early retirement using your 401(k), IRA, or other qualified retirement plans but don't want to pay the 10% early withdrawal penalty, Rule 72(t) might just be the solution to your penalty dilemma. Under IRS Rule 72(t), you're allowed to take penalty-free early withdrawals from your retirement accounts for either 5 years or until you reach age 59 1/2, whichever is longer.

If you start a 72(t) with less than 5 years before you reach age 59 1/2, you must continue the distribution for 5 years. For example, if you are currently 56 years old, it must run until you are age 61. However, if you are age 49, then Rule 72(t) runs until you reach age 59 1/2, and then stops. After you reach the end of the 72(t) age requirement, you can withdraw as much as you wish.

Currently, the IRS offers 3 different methods to determine the payout. If you are seriously considering this, you should have a conversation with a financial professional to determine which payout method is the most beneficial for your circumstances. Each payout method will tell you how much the payout will be based on the various factors (ie, your age, beneficiary age, account balance, interest rate, and life expectancy) based on the IRS's mortality table. Payout methods include the following:

• Life expectancy method. This is the simplest method for calculating your substantially equal periodic payment (SEPP), but it also produces the lowest payment. It simply takes your current balance and divides it by your life expectancy or joint life expectancy.

• Amortized over life expectancy. With this method, the amount to be distributed annually is determined by amortizing your account balance over your life expectancy or joint life expectancy at an assumed rate of interest.

• Annuitized over life expectancy. This method uses an annuity factor to calculate your SEPP. This is one of the most complex methods and produces nearly the same result as the amortized method. The IRS explains it as taking the taxpayer's account balance divided by an annuity factor equal to the present value of an annuity of $1 per month beginning at the taxpayer's age attained in the first distribution year and continuing for the life of the taxpayer. For example, if the annuity factor for a $1 per year annuity for an individual who is 50 years old is 11.109 (assuming an interest rate of 8%), an individual with a $100,000 account balance would receive an annual distribution of $9002 ($100,000/11.109 = $9002). This calculator uses the UP-1984 Mortality Table, which is a non-sex-based mortality table and an acceptable mortality table for the IRS. Please note that your annuitized SEPP is based on your life expectancy only, and is not based on the age of your beneficiary.

For purposes of illustration, the following tables are examples of the life expectancy method—because it allows for the largest distribution—as well as other 72(t) distribution methods.

This is not a suggestion to begin using retirement assets before retirement. It goes without saying that retirement assets should be sacrosanct until they are needed to carry us through the retirement years of our lives. A thorough analysis should be done of one's financial holdings to determine if it is financially feasible to retire early. For physicians who have worked hard to arrive at financial security, this strategy is one that you should contemplate if you are considering retiring early.

Additional information on 72(t)s can be found on the IRS Web site at www.irs.gov, or you can perform a free analysis using the 72(t) calculator located online at www.krasneyfinancial.com in the "Visitors" section found under "Research," then under "Calculators."

Jonathan Krasney is president of Krasney Financial, LLC, in Brookside, NJ. He is an expert in personal finance issues

for high-net-worth individuals and often assists clients in estate planning issues, tax

management, bonds, mutual funds, and charitable giving. He has appeared on CNN, CNNfn, and can be

seen regularly on CNBC's Power Lunch "Making Your Money

Work" segment. Mr. Krasney welcomes questions or comments at 888-572-7639 or info@krasneyfinancial.com.