Coasting in Retirement Ep 18: Be Careful using IRS Rule 72(t) to Retire Early
Segment 1 (Show Open):
Good afternoon, everyone! Welcome in. Welcome to Coasting in Retirement! That’s. Right. Thanks for joining us today, we’re excited to have you! I am your host, Josh Null, alongside co-host Michelle Lee Melton, the Batgirl to my Batman, helping this country boy sound out 3 syllable words…Michelle, how are you? Here we are once again in Coastal College’s recording studio, beautiful downtown Fairhope, hatching up another great show for those of you tuning in!
Listeners: Michelle and I are here today to discuss financial topics relevant to those of you in or near retirement living your best life along our part of the gulf coast. If you’re just tuning in to our show, welcome, you’ve listening to Lower Alabama’s most dynamic financial radio show. Here’s what we’ve got in store for you today: First segment – deep dive on our topic of the day. 2nd segment - at about 20 minutes past the hour - fan favorite, “Michelle with the News of the Week”. 3rd segment, roughly 40 minutes past the hour, ”Josh’s Crystal Ball and…(Michelle:) Big Mouth”. That’s right, big mouth. So buckle up, we’ve got a lot to get to!
Quick background on me for those new to the show. Again, my name is Josh Null, I am a fee-based financial advisor, I hold my FINRA Series 65 securities license, and I am the owner of Gulf Coast Financial Advisors, an independent investment management and financial planning firm with offices in Fairhope and Orange Beach, Alabama. You can find more information on me and Gulf Coast Financial Advisors by visiting our website gulfcoastfa.com, or feel free to give us a call at 251-327-2124. If you missed that, don’t worry, we will repeat our contact info several times throughout the show!
Alright Michelle, so on our last episode we did a thrilling deep dive into the good, the bad and the ugly of Roth conversions and back-door Roths. Listeners – if you missed that episode, you can find it on our website or on Spotify. This week, we are going to stay in that same vein, talking about yet another somewhat dry concept but very important rule that has the potential to do real damage to your retirement account if handled improperly. It's called the IRS Rule 72(t). The t is in parathesis or is that colons? I was telling my daughter Josephine that I wasn’t’ sure I could pick out an adverb in a sentence anymore.
I have no doubt that some our listeners are nodding their head right when I mention 72(t), possibly some of you all even once attended a dinner seminar about “early retirement”, but for those of you tuning in that are not familiar with this concept, let’s start with a basic definition: Rule 72(t) is a section of the IRS code that covers the exceptions and processes that allow you to withdraw money from your qualified retirement accounts be age 59 ½ and not pay the typical 10th early withdrawal penalty. Doesn’t sound too bad, right? But as with anything that has this level of impact your retirement – possibly a HUGE effect on your chances of outliving your money - we need to look under the hood at how these things really work.
First, when referring to this concept, most people in my industry just use the term “72t”, or “Rule 72t” like I just did, but remember, the 72t just refers to the part of the IRS code that allows early withdrawals. The actual mechanism used to calculate and facilitate these early withdrawals is called “Substantially Equal Periodic Payments”, or SEPPs for short. That’s 2 “PP’s” in the title, so for sake of clarity for our listeners, we are NOT referring to a SEP IRA, which stands for Simplified Employee Pension, a form of a qualified retirement plan and not related to our discussion today. Back to SEPPs. These “substantially equal payments” must be set up for a minimum of one withdrawal per year for five years or until you reach 59½ years of age, whichever comes later, in order to avoid the 10% penalty. Remember this fact because we will circle back to it – there’s a severe downside for screwing this up.
Now, why would someone want to access their retirement accounts before age 59 1/2 you ask? First, a positive reason – maybe an investor is in a position to retire early and because they hold most of their assets in qualified plans, they need a way to access those accounts without penalty. Typically, this will involve a pretty healthy account balance, or at least it should, and hopefully a qualified financial professional has run some long-term income calculations. And this does happen – people retire early all the time. Unfortunately, though, as with many “emergency” reasons for accessing your retirement accounts early, the 72t is often used because an unexpected financial need or life change happened, such as a layoff from your job. Sometimes people are just worn out from working a physically or mentally demanding job and want to retire early but need the money from their qualified accounts to do so. Whatever the case may be, this is where the shady characters come in – when people are most vulnerable.
Before we get to the shady characters, let’s talk about some of the rules of utilizing rule 72t. First, not every type of qualified retirement plan is eligible. Your 72t exercise will need to involve either a 401k, a 403b, a 457b or an IRA. So much jargon Michelle! Quick explanation on that jargon - 401k’s and 403b’s are very similar, with pre-tax contributions and tax deferred growth, but the 401k is the private company option while 403b’s are typically for government work and non-profits. 457b’s are deferred compensation plans.
Second big rule – the retirement plan can’t be employer managed, which means you cannot take 72t early withdrawals from a retirement account you hold with your CURRENT employer. Third thing to remember – you will still owe income taxes on your withdrawal amount at your current tax rate. These 3 rules I just listed – has to be a certain type of qualified account, can’t be at your current employer, taxes will be due – these are all pretty easy to remember. But of course, I saved the biggest brain damage rule of 72t early withdrawals for last, Michelle, because it involves math, some would argue fuzzy math, and if you screw it up – and it happens – the penalties are H.E.F.T.Y.
So first, let’s talk about your withdrawal amount. This will be determined by IRS life expectancy tables, and it’s your job to determine which applies to you. Common sense would tell you that if you wanted to withdraw a total of $50k from an account over the course of 5 years, you would simply take $10k per year. But no. It’s not that simple. There are 3 IRS life expectancy tables: uniform lifetime, single life and joint & last survivor. These tables revolve around whether you are married or not, and how much of an age gap exists between you and your spouse.
The math part kicks in once you pick the right life expectancy table. As opposed to life expectancy tables, you do have some discretion to pick the payout method that best fits your situation. There are 3 basic SEPP distribution methods: Required Minimum Distribution, Fixed Amortization and finally, Fixed Annuitization. It would absolutely put Michelle to sleep if I went thru all of the calculations of each of these methods, so lets just say this: in general, use the RMD method if you want to keep the withdrawal amount as low as possible, and I think it’s fair to say that you would be best served with a qualified financial professional and/or a CPA to calculate the other. Because remember what I said at the beginning of the show about making sure you don’t screw this up?! Here’s why:
If you modify your SEPP by taking an annual amount that is different from the annual amount that was originally determined, you will be subject to both the 10% tax on the total distributions in that calendar year and a recapture tax that is equal to the total amount of the 10% tax that would have been imposed for the prior years of the SEPP, PLUS interest. Also, hefty fines apply if your calculations are off and your account doesn’t have enough money to make the full 5 payments, for example, you come up short in the 4th or 5th year.
That’s why people who successfully use Rule 72(t) tend to be closer to 59 ½, meaning they are not committing to no more than a 5 year lockup period, and tend to have a substantial chunk of other money they can use for extra and unforeseen expenses, meaning they will not need to change the fixed payment amount.
So, these are the basics of Rule 72t, and if you’re still a little confused, don’t feel bad. It can be confusing. We are going to circle back to some of this information in our next 2 segments to help explain more. Remember - Rule 72t can be a convoluted path, with a lot of downside, that’s why it so important to treat this concept with caution and deference and not get caught up in a fancy sales presentation about retiring early. In fact, Michelle, in our next segment were going to discuss some of this chicanery and shenanigans around 72t transactions, including one of the most egregious examples EVER that happened down here in Lower Alabama.
Have you been thinking about utilizing rule 72t? Interested in a private conversation about your retirement options? For a one-on-one confidential discussion about your investments for financial plan, give us a call at 251-327-2124 or make an appointment on our website gulfcoastfa.com. That’s gulfcoastfa.com.
Alright folks, coming up next! Every week Michelle and I scour the interwebs for helpful financial articles related to our topic of the day, especially articles that pertain to those in or near retirement. Join us after the break to hear Michelle and I discuss this week’s relevant headlines in our “Michelle with the News of the Week” segment. Don’t turn that dial!
Segment 2 - Michelle with the News of the Week:
Josh: “Welcome back to Coasting in Retirement, your host Josh Null here! As we discussed before the break, every week Michelle and I scour the interwebs for helpful financial articles related to our topic of the day, especially articles that pertain to those in or near retirement. Our job is to help you all understand how these headlines impact you, especially when it comes to your money! So, without further adieu, here’s “Michelle with the news of the week!”:
1. Michelle: Alright Josh, let’s get started with a recent article from USA Today simply titled “What is rule 72(t)?”. Now to be honest, up until last week’s episode where you planted the seed that we would be discussing 72t’s on this week’s episode, I had never heard of this rule. In fact, I thought the number 72 was in reference to the RMD age that we discuss often. To my surprise, there’s a ton of articles about this concept, but I felt that this particular USA Today article cut to the chase the best. A lot of what we talked about in the opening segment can be found in the piece, but I was surprised to learn that basically ANYONE is eligible to use Rule 72t, not just folks in their mid 50’s or older. It seems to me that this could be enticing to someone younger with a 401k balance but not a long-term outlook – what are your thoughts?
Josh: Retirement accounts are for the long term, not for emergencies or accessing early in life. Draw down risk, running out of money, etc.
https://www.usatoday.com/money/blueprint/retirement/rule-72t/
2. Michelle: Next up is a new site that we haven’t referenced before called Commonwealth. On their blogsite they have an article titled “Are 72(t) Plans Too Good to Be True? (For Most of Your Clients, Yes)”. This article covers a lot of the same ground as the USA Today article we just referenced, but I found one important part that we only touched on briefly. I think what gets lost in all of this conversation about using rule 72t to retire early is the fact that your retirement account is going to get drained earlier than if you wants until “normal” retirement age. So Josh, do you agree with this article, and specifically, what are thoughts about decreasing someone’s retirement bucket early?
https://blog.commonwealth.com/are-72t-plans-too-good-to-be-true-for-most-of-your-clients-yes
3. Michelle: Ok, so on our last episode, we laid out the Good, the Bad and the Ugly of Roth Conversions and Back-Door Roths. You specifically cited the shenanigans that unscrupulous salespeople and brokers used to convince folks to do a Roth conversion when it may not have been in their best interest. You also told me that a lot of nonsense happens in the 72t world as well. And I must say – you appear to be right. My research on 72t’s led to many attorney’s blogs that listed several egregious examples of rule 72t abuse. One of the more interesting articles I found was on the website for Georgia-based The Perry Law Firm and was simply tilted “Early Retirement Scams”. Here’s what stuck out to me – the brokers referenced in this article about rule 72t scams told their clients that they could withdraw 7 to 9% of their account every year, saying they could do this for 30 years or more! I know you often talk about a 4 to 5% withdrawal rate, and what it takes in earned interest to maintain that. So why in the world would someone promise that high of a rate?
https://pageperry.com/early-retirement-scams
4. Michelle: Last article Josh, and I must admit that you warned me ahead of time that one of the most egregious examples of rule 72t fraud happened right in our backyard, but I was still shocked at the severity of it. This article is from InvestmentNews and is titled “Scammed Exxon Mobil retirees applaud sentencing of ex-Securities America rep”. The broker’s name is David McFadden, and apparently, he lived in Orange Beach but somehow ran a financial services company in Baton Rouge. According to the article, over 150 of McFadden’s clients lost tens of millions on his fraudulent early retirement scheme, that utilized…IRS Rule 72t. I did a little more digging, and on the FBI’s website you can find the sentencing announcement. Not only did McFadden falsely promote his qualifications as a CPA and financial planner, but he also admitted that he falsely represented to his clients that they had enough money to retire using IRS Rule 72t to make early withdrawals, saying that variable annuity he was selling them was totally in their best interests. This article is heartbreaking. This stuff is complicated, and I can see how people can get misled – what can they do to avoid traps like these?
https://www.investmentnews.com/scammed-exxon-mobil-retirees-applaud-sentencing-of-ex-securities-america-rep-26577
https://archives.fbi.gov/archives/neworleans/press-releases/2010/no012110a.htm
Josh: Michelle, great job as always with the headlines, these are all important pieces of information that impacts those in or near retirement! Listeners – if you have questions around the topics in our headlines of the week, or questions related to your investment strategy or financial plan, you can set an appointment by calling us at 251-327-2124 or by clicking calendy link on our website, gulfcoastfa.com. It’s in the upper right-hand corner. It’s a free, no pressure, no obligation meeting.
Alright folks, coming up next : Josh’s Crystal Ball and Big Mouth. What have been some of my predictions? Have I been right? Was I ever wrong? How wrong? What do I think is going to affect investors in the near future? We talk about all of these things and poke a little fun at my big mouth. Stay tuned!
Segment 3 – Josh’s Crystal Ball and Big Mouth:
Welcome back! Your host Josh Null here, along side co-host Michelle Lee. So, I am opinionated, I have strong opinions at times, I would say a radio show host that isn’t probably wouldn’t be very interesting to listen to. And I am paid in my profession to offer professional guidance and opinions to my clients, otherwise what use am I? Sometimes I feel so strongly about something that I talk about it publicly, on the various podcasts and radio shows I’ve had, sometimes I’ll even make predictions, and while I usually proved right, there are times I swing and I miss. Want to hear me beat my chest or maybe…eat a little crow? Then let’s get at with Josh’s Crystal Ball and Big Mouth. Alright Michelle, what’s first?
1. Michelle: Alright Josh, you stated that you thought Federal Reserve Chair Jerome Powell would take a hawkish tone towards inflation in his recent speech at Jackson Hole, WY, which would result in a mild to medium stock market sell off. You got the first part right – in his speech, Powell noted that while inflation has tumbled in recent months, it isn’t yet at an acceptable level, and that the central bank is prepared to do whatever it takes to bring inflation down to the 2% target. BUT, you got the second part about a market sell-off wrong – while the major indexes broadly fell that day, the market rallied in the afternoon, and has continued a mild rally over the past few days. 2 questions: why do you think the market is ignoring Powell’s stance, and what does your crystal ball say about the market moving forward?
Josh: It literally makes no sense. See if you can find which companies are carrying the rally. And talk about the inverted yield curve. Stop with the 2% I don’t day trade or tiem the market
2. Michelle: So Josh you’ve stated many times that it was just a matter of time before one of the financial regulatory bodies – either the SEC or Finra – would put significant pressure on state insurance commissioners to clean up some the “guaranteed return” language used by some salespeople when pushing certain annuity products, such as fixed index annuities. But based on some publicly produced content we’ve heard recently, that doesn’t appear to be the case, with several references to “a guaranteed rate of return with no downside”. So, tell us why you think these types of statements are so misleading, BUT also let us know why your big fat mouth missed so badly when spouting out the opinion?
Josh: Talk about the different kinds of annuities and reference the previous episode (maybe time to do a revised episode about annuities). Be sure to say that there are guaranteed rates offered in FIAs and MYGAs, but those are typically similar to rates you would find in other fixed interest rate investments, say 3-4%, not the implied type of higher stock market-based returns, say 7-9%. The explain how insurance salespeople use the gray area when making these guarantees – return of your money, not on your money – and how there are income riders that guarantee a higher payout each year but that is not the same as return on principal. Also note that most people making these claims initially do not register with the SEC or Finra thru securities license, they are insurance licensed only.
3. Michelle: Next up Josh, something we touched on last week: investment client’s best interest legislation. As we discussed, the Department of Labor has worked for years to institute rules around fiduciary requirements, continuing to push forward with their current version called the “Conflict of Interest in Investment Advice” rule. While the DOL has had certain issues getting past various lawsuits, the SEC’s similar action, called Regulation Best Interest, or “Reg BI” for short, was actually implemented way back in June of 2020. You’ve said that all of these rules related to being a fiduciary, acting in your client’s best interests and either eliminating or spelling out conflicts of interest would result in more and more “commission-based brokers and broker-dealer reps” moving towards the fee for service model, in some cases even dropping their Finra registration required to collect any type of commission. These seems like a lot of position and posturing, so please enlighten if you feel your big mouth was right, and if so, what all these even means to the everyday investor.
https://www.investmentnews.com/how-advice-standards-have-converged-3-years-into-reg-bi-238787
4. Michelle: Last one Josh, you said that a combination of uncertain stock market conditions, continuing stock market volatility and an aging population would lead to an increase in annuity sales. Well, according a fresh off the press article from Financial Advisor Magazine, annuity sales jumped to $183 billion dollars in the first half of 2023, a 27% increase over last year! The article goes on to state that increased sales was pretty much across the board, with significant sales increases in fixed index annuities, multi-year guaranteed annuities – called MYGAs, and my favorite, Single Premium Immediate Annuities, or SPIAs. The only type of annuities that missed the boat were Variable Annuities, or VA’s. So obviously your crystal ball forecast was correct, but did you anticipate annuity sales going up this much?
Josh: talk about how this goes against the narrative that annuities are fading away, they are not, give the reasons why, and re-explain why this makes you so adamant that investors know the truth about annuities so they don’t get mislead.
https://www.fa-mag.com/news/annuity-sales-hit-record--183-billion-in-first-half-of-2023-74459.html#:~:text=Fixed%2Dincome%20annuities%20also%20set,investment%20growth%20with%20principal%20protection.
Well listeners, I hoped you enjoyed a peak behind the curtain on how I form my opinions and predictions, and more importantly, that I’m willing to admit when I am wrong. Which isn’t very often, but still. Now, to our listeners that have more questions the various investments and topics we discussed in this segment, we invite you to reach out to us. Call us anytime at 251-327-2124 to make an appointment or find us at on our website at gulfcoastfa.com.
Folks, that’s it for us this week here at Coasting in Retirement! I want to give a huge thank you to my lovely co-host, Michelle Lee Melton, a thank you to our awesome radio station 106.5, many thanks to the provider of our show music, local band Sloth Racer, and as always my sincere appreciation for all of your out there that have been listening and joining us on this journey. We would love to be a part of your journey as well. Until we talk again next Sunday, have a wonderful and productive week. This has been Coasting in Retirement with Josh Null!
Disclosure:
Advisory products and services offered by Investment Adviser Representatives through Prime Capital Investment Advisors, LLC (“PCIA”), a federally registered investment adviser. PCIA: 6201 College Blvd., Suite#150, Overland Park, KS 66211. PCIA doing business as Prime Capital Wealth Management ("PCWM") and Qualified Plan Advisors (“QPA”). Certain services may be provided by PCIA affiliates. In this format, Josh Null provides general information, not individually targeted personalized advice, and is not liable for the usage of the information provided. Exposure to ideas and financial vehicles should not be considered investment advice or a recommendation to buy or sell any of these financial vehicles. This information should also not be considered tax or legal advice. Past performance is not a guarantee of future results. Investments will fluctuate and when redeemed may be worth more or less than when originally invested.