A. The 72(t) strategy is named for the section of the tax code that sets out exceptions to the IRA early withdrawal penalty. The IRA allows you to avoid the penalty (if you are younger than 59 1/2) if you agree to take out "substantially equal periodic payments" (SEPP) from your traditional IRA.
What are the conditions?
The payments must be withdrawn for a minimum of five years or until you turn 59 1/2, whichever comes later. For example, if you are 50, you must take payments for at least nine and a half years. If you are 58, you must take payments until at least age 63.
What are the tax consequences of 72t?
Distributions will be taxed at your ordinary income tax rate. Once you start taking distributions, you cannot make new contributions to the IRA or take additional withdrawals. If you violate any of the rules, you will be charged penalty.
How much are the distributions?
The IRS sets three methods to calculate 72t payments.
The annuitization and amortization methods are similar. You must take same amounts each year.
The distribution method allows variable (and often smaller) payments each year.
You can use the calculator at 72t.net to compare the numbers under the three methods.
How to set up 72t payments?
You can call your IRA custodian to set it up. At tax time, make sure the form 1099-R you receive has code 2 in box 7, which tells IRS the distribution is taxable but not subject to penalty.
The Bottom Line
The biggest disadvantage of 72t is inflexibility. If you are eligible for other early-withdrawal penalty-free conditions, consider the other methods first.