Senior divorcing clients and those facing the loss of the primary wage earner spouse may find relief in the IRS Rule 72(t). This IRS rule allows for penalty-free withdrawals from IRAs and other tax-deferred retirement accounts like 401(k)s and 403(b)s, so long as certain conditions are met.
The key aspects of 72(t) are:
Withdrawals must be taken at least annually over a period of 5 years or until age 59 1/2, whichever is longer. This is known as the "payment term."
The annual payments must be calculated using one of the IRS-approved methods: Required Minimum Distribution, amortization, or Annuity Factor.
Once the payment schedule is set, it generally cannot be modified for the duration of the term unless the account owner becomes disabled or passes away.
EXAMPLE: A 56-year-old divorcée was awarded a significant amount of Exxon stock in her divorce settlement. She was in poor health and unlikely to return to work. Her only other income was $1,500 per month in Social Security Disability Insurance (SSDI) payments.
GOALS:
Generate funds for living expenses and medical costs.
Supplement her disability income.
Diversify her assets for growth.
Avoid outliving her savings.
The challenge would be to provide penalty-free income from her IRA without triggering the 10% early withdrawal penalty.
SOLUTION: split the IRA into two accounts. One was invested more aggressively for long-term growth. The other was used to generate the 72(t) payments.
By starting the 72(t) payments at age 56, she would be able to access the IRA funds penalty-free. The payments provided living income in the short term. Meanwhile, the ‘growth’ IRA remained invested with a longer time horizon.
After completing the 72(t) term at age 59 1/2, both IRAs could be recombined and invested holistically for lifetime income. The 72(t) approach met all the client's objectives:
Penalty-free IRA withdrawals funded her living expenses.
Assets remained invested for growth in parallel.
At 59 1/2, she gained unrestricted access to the full IRA balance.
The keys to successfully implementing 72(t) are:
Understand the Client’s cash flow needs with some reasonable margin and calculate the payment method appropriately.
Stick to the payment schedule once set.
Be aware modifying or stopping payments can incur penalties outside of statutory time frames.
Rule 72(t) provides senior divorcées, early retirees, and others with needed access to retirement funds prior to age 59 1/2. When properly set up and with disciplined spending this can be a valuable retirement income tool for Financial Advisors to consider for their divorcing or retiring Clients.
If you are thinking of, or in the middle of a divorce, we want you to know you're not alone and we’re here to help. If you would like to discuss how we can assist you with your future plans, please give me a call at 469-556-1185.
Geni Manning
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