Retirement Account Distributions: 59½ & 70½ Two Important Age Milestones Everyone Needs to Know - Part 1
A frequently asked financial question is, “Now that I’ve saved up for retirement, when can I access my retirement funds and when do I have to start taking money out?” All too often we spend so much time planning for retirement and accumulating assets that we forget to consider the most efficient way to draw income from retirement accounts.
When taking distributions from retirement accounts there are two important age milestones we should know and understand.
Age 59½ is the first important age milestone everyone should be aware of. In most cases you need to wait until at least age 59½ before taking a distribution from a retirement account or a tax-deferred investment without a penalty. Most distributions withdrawn from a taxable retirement account before age 59½ are not only subject to income taxes, but also a 10% early withdrawal penalty – you could potentially lose up to 50% of the distribution to income taxes and the penalty.
There are a few exceptions to this rule, such as medical insurance premiums for those who are unemployed, certain education expenses and even first time homebuyers, but they are limited. There’s also a special exemption for qualified retirement plans, like a 401(k). The regulations related to qualified retirement plans state that if you reach age 55 and are retiring, you can tap into your plan without an early withdrawal penalty. There’s also an exception for beneficiaries of an Individual Retirement Arrangement (IRA) account that allows them to take distributions without the 10% early withdrawal penalty.
Should it become financially necessary to draw an income from a retirement account prior to age 59½, there’s also an exception to the early withdrawal penalty called a 72(t) distribution. This distribution method is outlined in section 72(t) of the Internal Revenue Code, hence the name. This section of the tax code states that you can avoid the 10% early withdrawal penalty if you set up and receive “substantially equal periodic payments” from your retirement account for a minimum of five years or until you reach age 59½, whichever is longer.
Setting up and drawing 72(t) distributions should not be entered into lightly because they definitely have a few drawbacks:
a) You cannot choose the amount of income you would like to receive. The “substantially equal periodic payments” are required to be calculated using one of three methods listed in the tax code.
b) Once the payments are started you cannot change the payment amount or stop the distributions if you no longer need them. Once started, the payments must continue until you reach 59½ or for a minimum of five years, whichever is longer. So if you’re going to turn age 59½ in a year or six months, it doesn’t make sense to set up a 72(t) distribution.
c) It’s very important to work with a financial advisor or accountant familiar with this distribution method. Once you set up a 72(t) distribution from an IRA you must be very careful not to disturb the distributions or the account itself. If for some reason you miss a payment or take an additional distribution, it will cause the entire 72(t) distribution structure to fall apart and all of the previous payments to be subject to the 10% early withdrawal penalty plus penalties and interest.
Another thing to keep in mind is that a 72(t) distribution is exempt from the 10% early withdrawal penalty, but it is still subject to income taxes, just like all taxable distributions from IRAs. Next, we’ll talk about age 70½.