How to make early retirement withdrawals without paying a penalty

Let’s say that, for whatever reason, it would be helpful for you to take some money out of your IRA or 401(k) before you’re technically supposed to (age 59½). Turns out you can – provided you’re ok with paying an extra 10% penalty on top of whatever you withdraw.

But what if that extra 10% is a deal-breaker for you? Well, then you might consider using SEPP (Substantially Equal Periodic Payments) – also known as Rule 72(t) after its place in the IRS code.

Simply put, you are allowed to withdraw a (very) specific amount from your IRA or 401(k) without paying any penalty on it, if you go on to withdraw that exact same amount every year for the next four years or until you reach age 59½, whichever is longer.

So there’s the big catch, obviously; you’re stuck with that one annual amount, no more and no less, for at least five years if not more. Fortunately, there’s a fair bit of leeway in what that annual amount can be.

The IRS gives you exactly three different options based on a secret-sauce formula of theirs that accounts for current interest rates and your account balance at the time. I won’t bore you with the details, but here’s an example of how SEPP could play out for a $1 million IRA at today’s interest rates for a married 55 year old:

The SEPP method (substantially equal periodic payments) offers several options for early retirement withdrawals

In this example the individual in question would choose one of the three options above and stick to it for 5 consecutive years. But if the individual were, say, 40 years old then he or she would have to make these withdrawals for, yep you guessed it, TEN years until they reach age 59½.

But what if the amount calculated is too much? That’s easy. Just split your IRA into two separate accounts and leave just enough in the first IRA (the one for which you are applying the SEPP) to get the desired amount.

So whether you’re an average Joe or a multi-millionaire, it’s true what they say: there ain’t no such thing as a free lunch. But that’s not to say it isn’t worth the price. It just depends on your taste and what you can afford.

Keep your options open, remember that everything is connected, and don’t miss the forest for the trees.

– Graham