The Basic 72(t) Rules
The general idea of annuitizing (using the 72(t) rules) is that you can tap your IRA before 59½ without a 10% penalty if you commit to a plan of withdrawals according to the rules set out in Section 72(t)(2)(A)(iv) of the Internal Revenue Code. You can begin a 72(t) payment schedule at any age, even if you are still working. There is no required starting age. However, if you want to annuitize a company retirement plan, you first must have terminated your employment with that company.

The payments must continue for five years or until you reach 59½ years old, whichever period is longer. Once you commit to 72(t)s from an IRA, you must continue with your chosen payment schedule from that IRA until you reach the end of the term. During the payment period the withdrawals cannot be “modified,” meaning the payments cannot be changed. They cannot be increased or decreased and the method cannot be changed during the term to a new method, even if the new method would have been an allowable method if it were used from inception of the 72(t) payment term. For example, if you started out using the minimum distribution method, you cannot switch to the amortization method during the 72(t) term because it produced a higher 72(t) payment. That would be considered a modification of the 72(t) payment schedule and would trigger the retroactive 10% penalty.

However under Rev. Rul. 2002-62, beginning on October 3, 2002, you can switch to the required minimum distribution method (the RMD method) from either the amortization or the annuity factor method.

Switching to the Minimum Distribution Method (or RMD Method)
Before you decide to switch from either the amortization or the annuity factor method to the RMD method, make sure you first consider the outcome.

One-Time Irrevocable Switch
This is a one time irrevocable switch to the RMD method. You must use it for the remainder of your schedule. If the payment under the RMD method is too small, you might be better off not switching and continuing withdrawals based on your existing schedule, even though that may be too much. If you need the money, it’s best to have too much than not enough. Unfortunately this ruling does not allow you to take anything in between.

Since you can switch at anytime, you should try to project the amount you would need to live on for the remainder of your 72(t) term and then figure out when you should switch to the RMD method.

For example, if you have five more years on your 72(t) term and you feel you will need at least $250,000 over that time, you may want to stick with your current plan that provides $80,000 per year for three years and then switch to the RMD method which might produce a payment of $10,000 per year for the last two years. That would give you $260,000 over the next five years and would hopefully meet your needs without wiping out your retirement account.

Will You be Working Again?
You may have started the 72(t) schedule when you were unemployed and determined you needed a certain amount to live on. If you are fortunate enough to be working again, or expect to be working soon, you may not need as much and the switch to the RMD method could work well for you.

The Assessment of the Penalty
If you do not stick to your chosen plan, or modify the payments, you will no longer qualify for the exemption from the 10% penalty. Actually, it’s worse than that, because the 10% is reinstated retroactively, to all distributions you took prior to age 59½.

Disclosure: This election is not suitable for all individuals and investors should consult a financial professional prior to make investment and account decisions.