Tax rule allowing early withdrawal of IRA money can be risky

Q I will be retiring at age 57. I am considering my options, one of which is a monthly withdrawal from my IRA, roughly in the 4 percent annual range, under Rule 72T for five years to get me to Social Security. As I understand it, this would be allowed without penalty. At the end of the five years, can I discontinue the payments and or readjust without penalty?

MATT

A First, a brief definition, since not everyone is aware of the IRS' Rule 72T. You can't take money out of a traditional IRA before age 59 1/2 without paying a 10 percent penalty on the amount you withdraw. However, you can escape the 10 percent penalty with Rule 72T.

Here's how it works: You commit to a fixed payout until you reach age 59 1/2 and for a minimum of five years (whichever comes last). That means in your case if you start making withdrawals at age 57 you'll have to stick to the schedule until you're 62 years old. The IRS offers you three options for taking your money out. Once you've passed the minimum requirements for time and age with a 72T withdrawal, you can then change your payment schedule.

Remember, the income you take out of the IRA during withdrawal is taxable at your ordinary income tax rate. And if you change the schedule or run out of money in the IRA during the commitment period, you will be assessed a penalty on what you've already taken out. That's why I'd suggest working with a professional if you decide to go the 72T route.

I don't know all the circumstances, and I know you're exploring options, but your question does raise two cautions. First, I think a 72T is a risky strategy for most people. Financial planners tend to worry that it creates a genuine risk of running out of retirement assets early.

My second caution is on Social Security. If you elect to start taking Social Security at age 62, you'll receive a lower benefit than if you waited until full retirement age. That may be the right move for you, but in many cases it's better to wait before filing for Social Security benefits. A good place to run the numbers is at www.analyzenow.com. It's the financial planning and retirement website run by Henry (Bud) Hebeler. He has several Social Security calculators, including one that will help you decide whether to apply for Social Security at age 62, 66 or 70.

Chris Farrell is economics editor for American Public Media's "Marketplace Money." Send questions to cfarrell@mpr.org.

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