ôô

Investing FAQs: How to Get Higher Returns, Retire Early, Do Rollovers, and Manage Multiple Accounts

It's time to get clarity on investing. Laura answers seven questions from the Money Girl community about a variety of investing and retirement topics. You’ll learn how to get higher investment returns, retire early, prioritize accounts, do rollovers, know when you should invest, and manage multiple retirement accounts. Cut the confusion and you'll have more success!

By
Laura Adams, MBA,
April 26, 2017
Episode #495

Page 1 of 3

 How to Get Higher Returns, Retire Early, Do Rollovers, and Manage Multiple AccountsInvesting for the future is one of the most powerful ways to create security, feel in control of your money, and reduce financial stress. But it can be difficult to get started when you don’t feel confident or need more clarity.

In this post, I’ll answer 7 questions from the Money Girl community about a variety of investing and retirement topics to help you create more financial success. You’ll learn how to get higher investment returns, retire early, prioritize accounts, do rollovers, know when you should invest, and manage multiple retirement accounts.

Free Resource: Retirement Account Comparison Chart (PDF download)  - get this handy, one-page resource to understand the different types of retirement accounts.

7 Questions & Answers About Investing

Investing Question #1: Carl says, “I recently heard about a way to retire early that doesn’t come with a retirement account penalty. Can you explain how to qualify for that?”

Answer:

If you’re a regular Money Girl reader or podcast listener, you know that I strongly recommend using retirement accounts, such as IRAs and workplace plans to save for retirement. They come with terrific tax benefits and legal protections that don’t come with regular investing accounts.

However, retirement accounts also have a major downside: you generally can’t take money out of one before age 59½ without paying a 10% penalty. The idea is that these accounts are meant to provide security in retirement and not to be tapped early or on a whim.

There are some qualified exceptions when you can take early distributions from an IRA that are penalty-free, such as paying for education, medical bills, or your first home. Roth IRAs give you the most flexibility, and I covered the rules for making withdrawals of both contributions and earnings in last week’s post and audio podcast, 4 Penalty-Free Ways to Use a Roth IRA Before Retirement.

See also: 10 IRA Facts Everyone Should Know

In addition to common exemptions, there’s an advanced and little-known rule you can use to avoid the early withdrawal penalty for any type of retirement account. It goes by a few different names that come from its numbered section of the IRS tax code:

  • 72(t) distribution 
  • 72(t) payment plan 
  • Substantially equal periodic payments 
  • SEPP plan

The 72(t) regulation allows you to set up a plan to take equal monthly or annual distributions from your retirement account, such as a traditional IRA or a Roth IRA. You can also set up a 72(t) from a workplace plan, such as a 401(k) or 403(b), if you no longer work for your employer.

On the surface, this sounds like an easy way to begin tapping a retirement account any time you want. Problem is, creating a 72(t) plan comes with restrictions and some risky consequences if you don’t use it the right way. 

The 72(t) regulation allows you to set up a plan to take equal monthly or annual distributions from your retirement account, such as a traditional IRA or a Roth IRA. 

The amount you can withdraw using a 72(t) plan is calculated using one of 3 accounting methods approved by the IRS. I won’t bore you with the details of figuring substantially equal periodic payments, but some of the factors that go into the calculations include your account balance, age, and life expectancy.

All payments you receive from a 72(t) plan that weren’t previously taxed, such as for a traditional IRA or traditional 401(k), will be subject to income tax, just like when you take distributions from those accounts in retirement.

It’s important to understand that once you begin taking 72(t) distributions, you can’t stop taking them for a certain amount of time. Once the plan is put in place you must take the periodic payments for a minimum of 5 years or until you turn 59½, whichever is longer.

After you complete a series of 5-year distributions and reach the age of 59½, you can take retirement distributions any way you like. However, for most traditional accounts, once you reach age 70½, you generally must take annual required minimum distributions, no matter if you used a 72(t) plan or not.

See also: 10 Costly Retirement Account Mistakes (Part 1)

Another issue with initiating a 72(t) payment plan is that you can’t make any new contributions to your retirement account or add any assets or rollovers while taking payments. It’s as if your accounts is frozen while a distribution plan is in place.

So, let’s get back to Carl’s question about who qualifies to use a 72(t). It’s available to anyone who owns a retirement account. But I’ll go a little deeper to explain who should use one.

Setting up an early distribution plan can be a huge benefit if you have plenty of money in your retirement account and are ready to retire before the official age of 59½. It’s a great way to start spending your retirement funds on anything you like—such as travel, medical expenses, paying down debt, or gifts to family—without having to pay expensive early withdrawal penalties.

Another situation when a 72(t) distribution makes sense is when you really need to supplement your income. Let’s say you get downsized from your job at age 50 and decide to transition into a less lucrative career or to work part-time. If you need additional income, you could set up a 72(t) plan and take substantially equal periodic payments until you reach age 59½.

But as I mentioned, hopping on the 72(t) payment train means the ride must last for 5 years or until you turn 59½, whichever is longer. So, after receiving payments for 9½ years, from age 50 to 59½, you could stop taking payments. Or you could keep the distributions coming in the same amount or even change it to any amount you like.

When executed properly, taking 72(t) payments can be a smart way to tap your retirement funds early. However, figuring out the allowable payment schedule can be very complex—you can’t just name your own amount.

When executed properly, taking 72(t) payments can be a smart way to tap your retirement funds early. However, figuring out the allowable payment schedule can be very complex—you can’t just name your own amount.

Taking too little, too much, or missing a distribution deadline can result in expensive consequences. In addition to owing income tax, messing up your 72(t) payments means that all your distributions will be subject to the 10% early withdrawal penalty—plus, interest on unpaid tax and penalties calculated from the original date you made an error. Ouch!

Therefore, always get help from a tax professional who has experience setting up a 72(t). Carl should weigh all his options carefully and never enter a 72(t) plan lightly. Ask yourself if you really need the money or have other sources to tap.

Make sure you can afford to trade your nest egg for an immediate cash flow. Taking payments now means that you drain the resources available to you later in retirement.

See also: 5 Retirement Account Options When You're Self-Employed

Pages

You May Also Like...

Facebook

Twitter

Pinterest