IRS Rule 72(t)

Does IRS Rule 72(t) Apply to ESOP Distributions?

IRS Rule 72(t) allows penalty-free early withdrawals from retirement accounts, including Employee Stock Ownership Plans (ESOPs), under certain conditions. Normally, withdrawing from an ESOP before age 59 ½ triggers a 10% early withdrawal penalty, but IRS Rule 72(t) provides an exception if distributions are taken as Substantially Equal Periodic Payments (SEPPs). SEPP Payments must be based on an IRS-approved method and continue for at least five years or until age 59 ½, whichever is longer.

Once SEPPs begin, you cannot make additional contributions or modify the schedule without incurring penalties.

SEPP Calculation Methods

When taking early withdrawals from an ESOP (or other retirement accounts) under IRS Rule 72(t), you must follow one of the three IRS-approved methods for calculating Substantially Equal Periodic Payments (SEPPs). These methods determine the annual amount you must withdraw in order to avoid the 10% early withdrawal penalty.

• Required Minimum Distribution Method
  • The annual withdrawal amount is calculated each year based on the account balance and life expectancy.
  • The amount you receive each year may vary based on the most recent calculation.
  • Uses the IRS life expectancy tables.
• Fixed Amortization Method
  • Calculates withdrawals based on the account balance, a chosen interest rate (within IRS limits) and life expectancy.
  • The amount you receive remains fixed each year.
• Fixed Annuitization Method
  • Uses an annuity factor from IRS mortality tables and a chosen interest rate.
  • Converts the account balance into equal annual payments based on life expectancy.
  • The amount you receive remains fixed each year.

The IRS allows a one-time, irrevocable switch from either the fixed amortization or fixed annuitization method to the required minimum distribution method. Other than that, changing or stopping SEPPs before the required period (5 years or until age 59 ½, whichever is longer) can trigger retroactive penalties plus interest. Learn more about IRS Rule 72(t) on the IRS website.

You can also contact us at (802) 503-8280 or welcome@onedayinjuly.com to speak with a financial advisor who is knowledgeable about Rule 72(t) and ESOP distributions.