Can You Work While Taking a 72t Distribution?

It is possible to access funds from retirement accounts before age 59½ without incurring the usual 10% early withdrawal penalty. This option is available through a provision of the Internal Revenue Code, specifically Section 72(t), which permits what are known as Substantially Equal Periodic Payments, or SEPPs. These payments provide a structured way to receive income from qualified retirement plans or Individual Retirement Accounts (IRAs) ahead of the typical retirement age.

Understanding 72(t) Distributions

A 72(t) distribution is an IRS-approved method to withdraw money from qualified retirement accounts before age 59½. The primary purpose of establishing a SEPP schedule is to bypass the standard 10% early withdrawal penalty that typically applies to such distributions. These payments must be “substantially equal” and are calculated based on the account balance and the account holder’s life expectancy.

Once initiated, these payments must continue for a specific duration, which is the longer of five years or until the account holder reaches age 59½. The IRS provides three approved methods for calculating these payments: the Required Minimum Distribution (RMD) method, the Fixed Amortization method, and the Fixed Annuitization method. While these distributions avoid the early withdrawal penalty, they are still taxable income and are subject to ordinary federal income tax, and potentially state taxes.

Working and Your 72(t) Payments

Earning income from employment or self-employment generally does not disqualify an individual from continuing to receive 72(t) payments. The rules governing 72(t) distributions focus on the integrity and consistency of payments from the retirement account, rather than the recipient’s external income or employment status. This means receiving a salary or business income does not, in itself, violate the SEPP rules.

Maintaining a valid 72(t) distribution schedule requires that the Substantially Equal Periodic Payments remain unchanged and consistent for the required duration. The IRS is primarily concerned with whether the established payment plan is adhered to, not whether the individual’s financial need for the payments has changed due to new employment. Therefore, a common misunderstanding is that working will automatically stop or penalize ongoing SEPPs.

The issue arises only if the individual modifies or discontinues the SEPP payments before the mandatory period concludes. This holds true regardless of the reason for the modification, even if it is because the individual no longer needs the income due to new employment. The 72(t) regulations provide an exception to the early withdrawal penalty for retirement funds, not to impose income limitations on the recipient.

Once a 72(t) payment plan is established for a specific retirement account, you cannot make additional contributions or rollovers into that account. Doing so would constitute a modification to the account balance, potentially jeopardizing the SEPP status. However, if you have other retirement accounts not part of the SEPP plan, you are generally free to contribute to them.

What Happens If Payments Are Modified

Modifying a 72(t) SEPP schedule before the required period ends carries financial repercussions. If payments are changed, stopped, or an additional distribution is taken from the same account outside the established SEPP schedule, the 10% early withdrawal penalty is retroactively applied.

Interest may also be assessed on these penalties, treating the penalty as if it should have been paid at the time of each distribution. This retroactive application of penalties and interest can result in a financial setback. The IRS imposes these consequences irrespective of the reason for the modification, whether it stems from new employment income, a change in financial needs, or any other factor.

Examples of modifications include withdrawing more or less than the calculated annual payment, or contributing new funds to the retirement account generating the SEPPs. Exceptions to these rules are in cases of the account owner’s death or disability. An allowable modification is a one-time, irrevocable switch from the fixed amortization or fixed annuitization methods to the Required Minimum Distribution (RMD) method, which does not trigger a penalty. If the account is completely exhausted due to adherence to an acceptable calculation method, no additional tax or penalties will be due.