Modeling a 72(t) SEPP in Early Retirement

Can I Retire Early? Planning for a 72(t) SEPP

A rite of passage on the journey to FIRE is understanding whether or not you need a 72(t) SEPP during your early retirement. Planning your future sources of income in a tax-efficient manner is huge.

Do you need a 72(t)? How can you model one?

Or, wait, should I do a 5-year Roth Conversion ladder instead?

Let’s look at a hypothetical early retirement and model a 72(t) SEPP, then discuss when you might be better off doing a Roth Conversion ladder instead.

What is a 72(t) SEPP? And what is a 5-year Roth Conversion Ladder?

In early retirement, some have the bulk of their money saved up in pre-tax retirement accounts. You saved up all that money, the last thing you want to do is pay a 10% early withdrawal penalty by pulling it out of an IRA prior to the age of 59 1/2.

Of course, there are exception to the IRA early withdrawal penalty (which I talk about in my bit on using QDROs to avoid paying the penalty. This is another very advanced FIRE technique that is rarely attempted—and also might be useful if you want to pull your money out of your 401k to invest in real estate).

Most can’t find an exception to the early withdrawal penalty. If that is you, FIRE doctrine states you should think about:

Substantially Equal Periodic Payment (SEPP) via IRS Rule 72(t)

What is a series of substantially equal periodic payments? Codified under IRS rule 72(t), it allows you to take money out of your IRA prior to 59 ½ without penalty. It is actually one of the penalty exclusions listed in IRS code, but because it is so different than the other exclusions, we are giving it full attention here.

However, extreme caution is indicated with a SEPP as if you blow it up, it all becomes taxable with a penalty. Generally, it is a good idea to plan this out well in advance. Get your CPA be involved, as well as the IRA’s custodian. Take meticulous care: do not mess with the underlying IRA (no additions or additional withdrawals), and take out your payment each year for as long as required. More on the mechanics later.

It is also interesting to note there is a 72(q) which lets you access non-qualified annuity funds prior to 59 ½ as well. I hope you don’t have a non-qualified annuity. But if you do, you can get at it too penalty free.

Roth Conversion Ladder

In order to pull off the Roth Conversions 5-year Ladder, you make yearly Roth conversions to pay for living expenses 5 years from now. Again, care must be taken with this plan!

As you know, you can pull out Roth CONTRIBUTIONS anytime without tax or penalty (even on backdoor Roth contributions). Roth CONVERSIONS, however, have a 5-year seasoning period. You can’t just take conversions right back out without a penalty.

This is confusing because there are two types of 5-year rules on Roth IRAs. The rule on conversions is created specifically to PREVENT folks from getting around the 10% penalty for early withdrawal on IRAs. No, you cannot convert to a Roth and then take the money out. You must wait 5 years.

The other 5-year rule is about taxation on the growth of a Roth and doesn’t really apply here.

So, if you need penalty-free IRA withdrawals in 5 years, pay the taxes this year by converting your IRA to Roth. After waiting 5 calendar years, you can pull out the money tax- and penalty-free. Even if you are less than 59 ½!

Why Doesn’t Everyone Do a Roth Conversion Ladder Instead of a 72(t)?

In order to do a Roth conversion ladder, you must have enough after-tax money in order to live on for 5 years, and to pay the taxes for the 5 years of conversions.

So, if you have a lot of money in your brokerage account, a 5-Year Roth Conversion Ladder may be for you. But if you only have pre-tax money, you are stuck with a 72(t) SEPP.

After you build your Roth Conversion Ladder, you have very low taxes as you have pre-paid the taxes during the ladder building process. This is done in a series… year one you convert for year six, year two you convert for year 7, etc. Eventually, 5 years from now you are going to be 59 ½ and no longer need to worry about the 10% penalty.

So, only if you don’t have enough after-tax sources of income should you consider a series of equal periodic payments. The 72(t). Hike.

An example of the SEPP 72(t)

Some folks want to retire in their 50’s. If they have a lot of money squirreled away in pre-tax retirement accounts (but no after-tax funds in order to do a Roth Conversion Ladder), they might consider a 72(t) SEPP.

Let’s look at a scenario where a 50-year-old couple considers funding a gap with a 72(t) SEPP. They have a long retirement ahead and some aggressive spending goals. They will work a bit part time, but don’t have enough income saved in the brokerage account to make it to 59 ½.

In order to make ends meet, they are planning on doing a 72(t) SEPP from 56-60, taking out about 40k a year.

How much do they need to set aside in a separate IRA in order to afford this 40k x 5 years? Well, it depends on which method they use (discussed below), but 40 x 5 = ~200k. Keep this in a separate IRA and the rest of the pre-tax retirement funds can be stored in a different IRA.

Let’s go the planning software and see what we can find out.


These folks have about 3M in assets, and plan on spending 10k a month after taxes. They each have a part time job which brings in about 60k a year.

Let’s see why they might consider a 72(t).

72(t) in early retirement

Above, we are looking at how much they pay in taxes each year relative to the tax brackets. They fill up the 12/15% bracket with income but note the jump at age 62. This is when their brokerage account runs out of money and they start pulling from their IRA. Note that this jumps them up into the 25% tax bracket and once RMDs start (at age 72) they rapidly go into the 28% bracket and above.

What a waste of all those lower tax brackets early on! And, it is never good to decimate the brokerage account down to zero. What if you had a large expense? Sure, you could pull money out of the IRA after 59 ½, but it is always wise to pull money out when you are at lower brackets. If you spike your income with a pre-tax withdrawal, you can spike your taxes too!

In this scenario they cannot do Roth conversions or a Roth Ladder because they can’t afford to! Again, in order to pre-pay taxes, you must have an after-tax source of income. Out of the box ideas for this might include a reverse mortgage, the cash value of a life insurance policy, or any other source of after-tax income. These are called buffer assets and I’ve discussed them at length previously.

Anyway, let’s look at the cashflows to see the problem in depth

Cashflows in a 72(t)

SEPP in early retirement

Without a 72(t) (bar above) and With a 72(t) (no bar above)

This is a busy table, but has a lot of interesting information. Look at the column with the taxable account. You can see by the time they are 62, it is decimated.

Compare this to this taxable column further to the right to see the effect of the 72(t). If you are interested, you can see what they need to pull out of the pre-tax accounts by comparing the columns labeled 401k, and see the effect of the 72(t) by comparing the IRA columns. Again, those columns with a bar above are without a 72(t) and those without a bar above are with one.

Finally, note that their total nest egg is smaller at the end of the series of periodic payments. This is misleading, however, as they have already pre-paid the taxes! If we take this plan to 90 years of age, they actually have a larger after-tax next egg and avoid some of the higher tax brackets when RMDs strike.

The point: don’t decimate your brokerage account! Use your pre-tax money, especially if you have enough that you are worried about IRMAA and large RMDs pushing your taxes up. Always use your lower tax brackets. I always like saying: would you pay 15 cents on one of your dollars now to avoid paying 25 cents in the future? Yes! There is time value of money, but pre-paying taxes can be an effective way of lowering taxes and surcharges in the future.

Summary: Modeling a 72(t) SEPP in Early Retirement

A 72(t) SEPP allows penalty-free withdrawals from retirement accounts prior to the age of 59 ½. Above, we see that it allows you to access your retirement savings maintain an emergency account.

The amount you take out is based upon a formula, but you can fund a specific IRA with just the right amount to give you the income that you need for at least 5 years AND until you are 59.  Let’s look at the distribution options now.

Distribution Options for the SEPP

The distribution options from a 72(t) SEPP are amortization, annuitization, and required minimum distribution. Each will give just a little different annual distribution amount. Honestly, it is not worth your time to try and figure out the differences between the three… just use an online 72(t) calculator and plug and play.

For posterity, here they are:

The Amortization Method

Annual distribution is the same each year. It’s determined by life expectancy and a chosen interest rate (federal mid-term rate).

The Annuatization Method

Distribution is the same each, just as above. It also uses life expectancy but a different interest rate (IRS single life annuity table). It is essentially the same as the first method.

Required Minimum Distribution and 72(t) SEPP

With the RMD method, you recalculate the distribution amount yearly. The amount is based on life expectancy. You start with much smaller payments with this method, but they may increase overtime.

Downsides of 72(t) SEPP

You are locked in once you start a substantially equal periodic payment plan.

That is, you must continue for a minimum of 5 years, and at least until you are 59. It is inflexible. You can only switch to the RMD from another method once during the plan. If you start with another method, there is no switching.

Don’t blow it up. If you do, all penalties and interest will be due. Take exactly what you should ever year. Don’t add to the IRA or take additional withdrawals.

72(t) SEPP online Calculator

Instead of doing the math yourself, google SEPP online calculator and you will find several options. I like CalcXML and the calculator by Bankrate.

And make sure you know what you are doing. Let’s look at what the IRS has to say about 72(t) SEPPs.

When Should You Take 72(t) SEPP?

Remember that generalized financial advice is wrong. It depends on your net worth, risk level and goals.

If you have an income gap and need pre-tax money, the maybe you should consider a 72(t) SEPP! Yes, you are pulling money out of a tax protected space, but the reason you put it there in the first place was to use in your retirement!

Also, it pays to have a tax plan during your early retirement. For instance, if you want to qualify for ACA premium tax credits, then you have to keep a watchful eye on your MAGI so not as to lose the credits. What is important is to have a plan. That is what early retirement is all about!

72(t) vs a Roth Conversion Ladder

Why not do a 5-year Roth Conversion Ladder?

Folks get a series of partial Roth conversions and the Roth Conversions Ladder confused. Partial Roth conversions are used to optimize your tax diversification by filling up your lower tax brackets during the tax planning window before Required Minimum Distributions drive you into high tax backets.

A Roth Conversions Ladder, on the other hand, is a way around the 10% penalty on IRA withdrawals prior to 59.5 years of age. Here, you convert money you need in 5 years to a Roth, pay the taxes, and then plan to spend the money if 5 years. The 5 years comes from one of the “5-Year Roth Rules,” specifically the one devoted to seasoning of the Roth. This rule is actually intended to prevent the “work-around” of converting money to a Roth and then taking that money out penalty free. There is a 10% penalty on Roth conversions that are not 5 years old until you are 59.5. Anyway, the 5-year rules get confusing because there are a couple of them and they depend on your age, so let’s not get into the too much more right now.

Can I Retire Early? What About a 72(t) SEPP?

So, should you have a 72(t) in your early retirement plan?

It is not a bad thing to consider if you have more money in your pre-tax retirement account than you need to survive once social security kicks in.

Consider a Roth Conversions Ladder if you have enough money in your brokerage account, or a 72(t) SEPP if you don’t.

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  1. OUTSTANDING 72(t) explanation!

    I’d been thinking about liquidating my IRA and just taking the 10% penalty hit to be able to semi-retire and start a business –
    And ran across 72(t) info the other day and your article today.

    Thank you, thank you for all you do.
    Have an awesome one. :^)

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