How Public Service Employees and Educators can use 72(t) for Early Retirement

Many public service employees and educators devote decades to their professions, often receiving pensions and retirement benefits later in life. However, what if you’re ready to retire before the traditional age of 59½ but still need access to your retirement funds? Traditionally, if you take money out of your retirement plans there will be a 10% early withdrawal penalty assessed when you file your taxes. One way around this is 72(t), which can be a valuable strategy for individuals in public service and education who wish to retire early and still access their retirement savings without incurring penalties.

What Is the 72(t)?

The 72(t), based on Code Section 72(t) of the IRS code, allows individuals to withdraw money from their retirement accounts (such as IRAs or 401(k)s) before age 59 ½ without paying the standard 10% early withdrawal penalty. This is done through a series of Substantially Equal Periodic Payments (SEPPs). The amount you can withdraw is calculated using specific IRS-approved methods and must follow the strict guidelines with a SEPP lasting for at least five years or until you turn 59½, whichever is longer. Remember, whatever, is longer, so if you start a 72t at age 57, you need to go until age 62. If you begin a 72t at age 50, you must go until 59½ with the SEPP.

Why Public Service Employees and Educators Might Need 72(t)

Employees in public service and education often qualify for pensions, but these benefits may not kick in until later in life. If you are ready for early retirement and need supplemental income before your pension starts or before you reach Social Security eligibility at age 62, a 72(t) plan could bridge the gap. For example, you might be an early career teacher or public service worker who often starts their careers early, meaning they may have worked enough years by their late 40s or early 50s to consider early retirement. There also might be pension gaps, in which your plan may not provide enough income to cover all living expenses if retirement occurs before the full benefit age. Accessing retirement savings early can help. Finally, work-life balance early retirement offers opportunities to pursue other passions, spend time with family, or even start a second career.

How 72(t) Works

To use the 72(t) rule, you must commit to taking Substantially Equal Periodic Payments (SEPPs). For example, with an account balance in a 403(b) of $400,000 with an interest rate of 4.45%, which could generate annual withdrawals of around $26,837 of annual withdrawals for at least five years or until you turn 59½, whichever is longer. The payments are based on your account balance, life expectancy, and an interest rate (up to 120% of the federal mid-term rate). 

Key Considerations for Public Service Employees and Educators

1. Plan Carefully: Early retirement can be incredibly fulfilling, but it requires careful planning. Consider your pension, Social Security benefits, and how long you need 72(t) payments to cover expenses. Talking to a financial planner makes sense to sort out what should be withdrawn first.
2. Strict Rules: 72(t) payments must continue for the full duration of the SEPP schedule. If you modify or stop the payments before the required time, you’ll face a retroactive 10% penalty on all previous distributions. You cannot take more or less than the required distribution from the plan. This provides little flexibility.
3. Complementing Other Retirement Plans: Public service employees often have access to 403(b), 457 plans or pensions, which can complement a 72(t) plan. Ensure that all your retirement assets are considered as part of your broader retirement strategy.
4. Taxes Still Apply: While the 72(t) rule waives the early withdrawal penalty, the withdrawals are still subject to ordinary income tax. Make sure to account for taxes when planning your budget.

Benefits of Using 72(t) for Public Service and Educators

1. No Early Withdrawal Penalty: The most significant benefit is avoiding the 10% early withdrawal penalty. This is crucial for anyone needing to access their retirement savings before age 59½.
2. Supplement Pension or Reduce Working Hours: If you want to continue working part-time or reduce your hours but still need income, SEPPs can supplement your pension or salary.
3. Flexible Retirement Timing: 72(t) allows you to retire earlier than expected, giving you control over your financial future while still meeting day-to-day expenses.

An Example of a Retired Teacher’s 72(t) Strategy

Imagine Sarah, a high school teacher, decides to retire at 50 after 28 years of service. Her pension doesn’t fully cover her living expenses, and she won’t have access to her full Social Security benefits for over a decade. However, Sarah has accumulated $400,000 in her IRA. By utilizing the Fixed Amortization Method under the 72(t) rule at an interest rate of 4.45%, Sarah could receive $26,837 annually for at least 9.5 years or until age 59.5, bridging the income gap until her pension and Social Security benefits increase.

Is 72(t) Right for You?

For public service employees and educators, the decision to use the 72(t) rule depends on your financial goals, retirement timeline, and other available resources. It’s crucial to consult with a financial planner to ensure that this strategy aligns with your long-term retirement plan. If managed properly, 72(t) can help educators and public servants retire on their terms, avoiding penalties and enjoying the fruits of decades of hard work. Contact me on the contact page below to learn more about my early retirement strategies.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning should work with an estate planning team, including personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.