How to Access Retirement Funds Early Using the 72(t) Strategy
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What if I told you there's a completely legal way to access your 401k and IRA money before age 59 and a half without paying that brutal 10% early withdrawal penalty? It's called the 72T, and it's one of the most powerful yet misunderstood strategies for early retirement. Today, we're diving deep into exactly how the 72T substantially equal periodic payment strategy works. Who

who it's perfect for, and the critical mistakes that could cost you thousands. We are going to dive deep into the numbers, so this is a great episode to listen to with a notebook and pen to take all the notes. If you've ever wondered how to bridge the gap between early retirement and traditional retirement account access, this episode is for you. ♪

Hello, hello, and welcome to the BiggerPocketsMoney podcast. My name is Mindy Jensen, and with me as always is my substantially equal but not periodic co-host, Scott Trench. Hey, Mindy, what's up? What's up? BiggerPockets has a goal of creating 1 million millionaires. You're in the right place if you want to get your financial house in order because we truly believe financial freedom is attainable for everyone, no matter when or where you're starting or whether all that money is in retirement accounts and you want to access it or get better returns in those accounts.

We are so excited to bring on an expert on this topic, John Bowens. John is the Director and Head of Education and Investor Success at Equity Trust. Really excited for this conversation today. John, welcome back to the BiggerPocketsMoney podcast. Thank you, Scott and Mindy. Always good to be here. John, I am so excited for this episode because the 72T is something that I have been looking into just because it's a great option. I'm not yet 59 and a half, not for a while. So I'm

This looked like something very interesting, but before we jump into it, let's define for everybody what the 72T is and what we're talking about today. Yeah, so I always like to start, Mindy, where does 72T come from? Well, if you go to the Internal Revenue Code, not that I would encourage a bunch of people to go out and check this out, but if you're interested and inspired by reading tax code, you would go to section 72T of the tax code.

Under 72T, you'll learn that when you distribute money from an IRA prior to the age of 59 and a half, and by the way, 401ks and other retirement accounts are included in this code section as well. If you take an early withdrawal,

Prior to the age of 59 and a half, there's a 10% penalty. But then you go further in section 72T. You actually go to 72T, the number two, and you find different exceptions to that 10% penalty. Then you go a little bit further and you go to 72T, the number two, the letter A, Roman numeral four,

And now you find what we call the substantially equal periodic payments exception. And this applies to just about everyone. And that's why I like to talk about this and educate folks on this, especially those that are looking to retire earlier, prior to 59 and a half, because they can be exempt

from the 10% premature withdrawal penalty. So it's not just the rule, but what are the exceptions to that rule? So walk us through the overview of what you do here. We've talked about this before on BiggerPocketsMoney, but let's give folks the overview of what this tool is and what optionality it provides for the

the investor. Yeah. And I think it's good to think about for someone that is under the age of 59 and a half. So they're under the qualified retirement age.

and they want to distribute money, let's say from a traditional IRA or a 401k from an old job that they rolled over, and all the money is in a pre-tax account. Now, Roth IRAs are treated differently, and I think we'll probably talk about that one as well. I'll put Roth IRAs aside for a moment. I'm just going to be talking about traditional IRAs. So you have somebody, let's just use the example, they're 50 years old, and

And they don't want to work until they're 59 and a half, but they can't start withdrawing from their traditional IRA until 59 and a half. If they start taking out prior to 59 and a half, again, there's a 10% penalty. So what the tax code allows us to do are these substantially equal periodic payments.

And so that 50-year-old can start taking money out every single year up until the age of 59 and a half, at which point in time, if they want to shut it off, they can. But once you turn it on, you can't turn it off. That's really important for viewers to understand. Once you start these substantial equal periodic payments, it's a series of payments. You have to take it out every single year. And you can't stop those distributions until you reach the age of 59 and a half,

Or you've taken those distributions for five years. So it's whichever is longer. So I'm 50 years old. I start the SEPP distributions. I can't stop until I'm 59 and a half. If I started, let's say at 58 years old, I'd have to wait five years before I can stop taking these distributions.

Now, the IRS allows us to choose from three different distribution methods or distribution calculations. The first is what we call the required minimum distribution method. The second is the fixed amortization method. And the third is the fixed annuitization method. Now, if you run the calculations and you can create a spreadsheet, for example, I have a spreadsheet with three tabs, RMD,

fixed amortization and fixed annuitization. And we can go through those in as much detail as you guys want. What I'll tell you is a lot of people like to look at it as small, medium, large. I will say that in some cases, the fixed amortization and annuitization ends up being very close to one another.

Generally speaking, the required minimum distribution method, you can take out far less in comparison to the fixed amortization and fixed annuitization method. So three different ways to calculate these distributions that you take on an annual basis. As long as you follow the calculations accurately, you comply with the rules, you do your tax returns properly, so work with your tax advisor on that.

you effectively eliminate the 10% premature withdrawal penalty. Now, do you have to pay ordinary income taxes? Of course you do. Why? Because a traditional account is all pre-tax, meaning as contributions were going in,

All of your growth is tax deferred. But when you take the money out, you have to pay taxes. So because you didn't pay taxes on the seed, you have to pay taxes on the crop. John, you mentioned three different ways to figure out how much money you're taking out.

Do you have to use the same method over the entire length of your 72T? Like if you start with RMD, do you have to do that for the whole five years or until you're 59 and a half? You can actually change it once in your lifetime from the fixed amortization or fixed annuitization

to the required minimum distribution method. This came about in 2002 under an IRS revenue procedure. The reason why the IRS did that, I suspect it was because it was just after 2001 in the dot-com bubble, where let's say the value of your account went way down because maybe you were invested all in the public markets and something happened and your portfolio value went way down.

And so you might end up having to liquidate positions to satisfy these distributions. So the IRS came in in 2002 and they said, hey, you know what? We're going to allow people to transition from the fixed amortization or annuitization method, which generally is a much larger amount that you have to distribute. And we'll allow you to choose the required minimum distribution method, which is method number one. But once you make that shift, you can only do it once in your life.

and you can't go back. So once you switch over to the RMD method, you're stuck in the RMD method, which may not be a bad thing. Here's something to consider looking at the RMD method versus the fixed annuitization or amortization method. And I'm happy to break those down in a little bit more detail, but just thinking about the theory of this, the required minimum distribution method

is going to be based on your life expectancy. So you're going to look at, for example, the single life expectancy table. You're going to take your portfolio balance of your IRA as of December 31st of the prior year. You're going to divide it by the life expectancy factor, and that's going to spit out the number that you have to distribute.

And that's going to change every single year based on the portfolio value of the previous year. So if you're somebody that wants to do these SEPP distributions, you want to make the calculations easy and you want to hedge against the portfolio value potentially going down and then having to liquidate and take a lot of money out and take losses in the market. The number one requirement of distribution method might be the most wise choice.

And so you take your requirement of distribution from that IRA under these SEPP distributions, and that gets recalculated every single year. Whereas the fixed annuitization and amortization, you calculate that at the very beginning, and that dollar amount stays the same in terms of how much you have to withdraw every single year.

Now, I'll mention that if someone is investing in, let's say, alternative assets, like our clients are generally investing in real estate and private equity and cryptocurrency, you do want to be cognizant of having some liquidity in there in order to satisfy those SEPP distributions on an annual basis.

All right, we got to take a quick break. The first of two substantially equal periodic breaks, SCPBs. And while we're away, you can head on over to YouTube and subscribe to our channel. That's youtube.com slash at BiggerPocketsMoney. Go check that out. And we'll be back in about 72 seconds. This Father's Day helped dad be all he can be with a gift from the Home Depot because he's not just dad. He's the handyman of the house, the plumber in a pinch, and the emergency mechanic.

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Welcome back to the show.

I think that for those who understand the 72T, for those who have a large pre-tax retirement account balance, and for those who want to retire early and access those funds, the most pressing question is, is this lock-in? I have to be locked in for five years or until 59 and a half with whatever distribution pattern I set. And I think there are two ways to really mitigate the risk associated with that lock-in, if

One is to really understand the nuance between those three distribution choices you can make, RMD, amortization, or annuitization. And the second is to simply create or roll over incremental retirement accounts. If you have five retirement accounts, for example, with $100,000 in each,

then you can set up substantially equal periodic payments for one or several of them, defraying the risk of your overall portfolio. Do I have the gist of the concept here correct in terms of how to strategize to defray that risk of locking in to substantially equal periodic payment distributions for a very long period of time? And if so, can you walk us through those three energization methods and comment on the creation of multiple retirement accounts?

So let's go through the three methods. Method number one, which I would consider to be the easiest to calculate. And also, it's important to understand that the calculation resets every single year or you do a new calculation every single year based on the value of your account in the previous year as of December 31st. So number one, the required minimum distribution method.

This is just like for someone that turns 73 years old and has to take a requirement of distribution from their pre-tax IRAs. You're just doing it under 59 and a half. And generally speaking, you're using the single life expectancy table. So you go to the IRS website. And by the way, there's calculators for this as well online to make it easy. You go to the IRS website and you look at the, we're going to say, single life expectancy table. And you look at your age and then it gives you a life expectancy number.

you take the portfolio balance as of December 31st of the previous year, and you divide that by your life expectancy rate at that age.

And that gives you the dollar amount that you have to distribute from your IRA. Now, Scott, you said something that's really important, and that is, do you have to take a substantial equal periodic payment distribution in totality of all of your pre-tax IRAs? The answer is no, you do not. For example, let's say you have a million dollars in a traditional IRA.

You break off $500,000 of that $1 million traditional IRA into a separate IRA. We're going to call this IRA a 72T IRA for the tax code 72T. Now, just like self-directed, self-directed is an industry term, right? Means you can self-direct into real estate and private equity and cryptocurrency. And that's what we do here.

72T IRA is just an industry term. It's not like you go to a custodian and set up a special type of IRA called a 72T IRA. Now, you do have to make sure that you set up the IRA and you process your distributions appropriately and you want to work with your custodian and your tax advisor on that. So using our example, Scott and Mindy, I take $500,000 of my $1 million. I move it over into this separate IRA.

I now do my required minimum distribution calculation. So I'm going to go into my Excel spreadsheet here and I'm going to plug in $500,000 because I think that was the example that you guys were giving before. So I have $500,000. Let's say I'm the age of 40 and I want to start taking these SEPP distributions. Can I start taking them at 40? Of course I can. Do I have to take them until I'm 59 and a half? Yes, I do. So let's run the numbers here.

We look at the life expectancy table, single life expectancy table, 45.7. I run my math. That comes out to be $10,940.92. So if I have a $500,000 IRA and at the age of 40, I start taking distributions based on the required minimum distribution method, that number is going to come out to be about $10,900. Let's call it $11,000 that I have to distribute in that year.

Now, let's say someone is 50 years old and starts to take these SEPP distributions. We run our same math, the required minimum distribution on $500,000. That comes out to be $13,000, about $800. Let's call it $14,000. So the 40-year-old has to take out about $11,000, and the 50-year-old has to take out about how much? $14,000, based on a $500,000 balance.

Now, let's say someone wants to or needs to take a little bit more. Could we bring in that full $1 million? Yes, we could. Could we set up a separate IRA, a third IRA, and have two separate 72T IRAs? I don't see why not.

So there are ways, again, to split the IRA and set up your separate 72T SEPP distributions. Now, that was the requirement of distribution method. The amortization method, a little bit more advanced in terms of calculation, but it could have some interesting benefits for the taxpayer, mainly that they can take more out under the amortization and annuitization in comparison to the RMD.

So what would that look like with the amortization method? Well, just like a loan amortization, it's a similar concept.

how to calculate this you'll find this on the irs website it's pretty straightforward you can run this on an excel spreadsheet by doing a simple payment method and there's calculations out there that you can find this and create a spreadsheet fairly easy or of course work with your tax advisor maybe who's doing your tax returns for you it's probably not going to be just a tax preparer probably somebody that's more of a tax advisor that can provide some more structured counseling

And so how does the calculation work with the amortization? Well, first you have the variable of your amount. Let's call it $500,000 using our same example. We then have to plug in an interest rate. Now, where do we get this interest rate from? Well, the IRS defines this interest rate and it's based on the federal midterm rate and you can make it up to 120% of the federal midterm rate.

Now, as of the recording of this, the federal midterm rate is about 4% when you look at the IRS website. So if we do 120% of that, it's about 4.8%. The higher the percentage, the more payment we're going to be able to get. So if you're somebody that wants to get more payment, you want to be using the highest interest rate in this calculation. Now, the IRS, here's another revenue procedure that came out. So the first one was in 2002 that I talked about.

The next one is 2022. So the IRS tells us that we are allowed to make that interest rate 5%. We can't exceed 5% or 120% of the federal midterm rate. So right now, the federal midterm rate

adding in 120% of that is not 5%. So we could just use 5%. We can go up to 5% in that case. So some people want to be able to take the maximum amount possible. So they go all the way up to that 5%. Now, let me give you the bottom line numbers because I know I'm talking about a lot of numbers here. For those that are trying to drive or run on the treadmill or out on a trail somewhere, let me just give you the numbers.

I gave the last example of the requirement of distribution method of $500,000. How much can you take out at the age of 50? At the age of 50, I said $14,000. Using the amortization method at the age of 50, using the 5% interest and a life expectancy, because you do have to use a life expectancy factor as well in your calculation, your payment calculation, it comes out to be $30,000.

So the RMD calculation in comparison to the amortization calculation, the amortization calculation gives us about double what we could take under the RMD calculation. Now it's all a game of trade-offs, right? So what's the trade-off here? The trade-off with the amortization is I can take more money out.

However, I have to understand that that amount stays fixed for the rest of me taking that distribution, which is 59 and a half or five years, unless I do the once in a lifetime shift back to the required minimum distribution method. Now, last but not least, and this one's going to be a lot quicker because it's very similar to the amortization, and that's the annuitization method.

Now, the annuitization method, that's going to bring in a slightly different calculation using the IRS published mortality table. And it's based off of an annuity factor. So you have to take your balance and divide it by a specified annuity factor that you calculate based on the IRS mortality table.

Here's the long and short of it, because we'd be here for another hour going through a spreadsheet. By all means, if we want to do that in a separate session, we can. I'm going to give you the bottom line, okay?

If someone is the age of, let's say, we're going to use 50 years old. So we got someone that is 50 years old, and I'm going to use the example of a million dollars. Let's say you have a million dollars in a traditional IRA, and you're using the annuitization method. The annuitization method is going to give you an annual distribution of contributions

close to $70,000. It's going to come out to be around $68,000. Now, interestingly, if you run the numbers, the annuitization method and the amortization method are very close to one another. Sometimes the annuitization method ends up being a little bit more, which is why some people choose that option.

But generally, we're going to see people start with the R&D method. If that satisfies their needs for distributions, they'll do that because of the ease of calculation and the ability to reset that R&D every single year. And then if that doesn't work for them, they'll move on to the amortization and annuitization method. This is our final ad break. We'll be right back after this. Buying a home is a huge milestone and a major responsibility. It's not just about the memories made there. It's about the financial future that comes with it.

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All right, we're going to convert the discussion to Roth IRAs starting now. This is a masterclass in these items here. And thank you. So to recap what I think I've learned, we've got three choices, the RMD method, the fixed amortization method, and the annuitization method.

If you want to withdraw the smallest possible amount, you go with the RMD method, especially if you're, by definition, trying to use this to access those funds early. That life expectancy factor is going to allow you to withdraw probably two-ish to two to at most three or four percent of the balance of your portfolio in a given year. Is that right? And these amortization or annuitization methods allow you to withdraw more.

You mentioned an important point. We also talked about how you can separate these accounts into two or more than two, as many as you want, really, individual IRAs, pre-tax IRAs, to begin these substantially equal periodic payments or 72T rule distributions on there. You will pay tax on these items. Now, we have another important component of the strategy of this. Let's say we have a $500,000 account.

Using our example, the 72T IRA, and we have that liquidity problem. What happens if the account does not have that liquidity, like it's invested in real estate or like it's invested in an index fund or something that must be sold in order to access it? What happens if there's a challenge doing that?

when it comes time. So let's say someone has stocks, mutual funds, traditional investments. The challenge is you really can't take a distribution of stocks and mutual funds from a brokerage account. Can't take a distribution from your IRA of those particular securities. So that's the challenge. What if the market goes down and now you have to fire sale, liquidate? That could be a problem, but it might just be what you have to do to satisfy the SEPP distribution.

Here are the consequences, Scott. I think that's what you're asking. What happens if I fail? I start the SEPP distributions, let's say at the age of 40. At the age of 45, I just stop doing them. What happens? The IRS will retroactively look back

and you will have a 10% penalty on all the amounts that you distribute. So it could be consequential, and you may just want to bite the bullet, sell while the market's down in order to then be able to satisfy your distribution. You're going to want to run a spreadsheet on that and determine what makes the most sense for you. Now, if you are under that amortization or annuitization method, and you have a circumstance like that, your amounts are much higher in comparison to the RMD method.

once in your lifetime, remember that you can shift to the RMD method. And the IRS put that in in 2002 under a revenue procedure because they understood that taxpayers could enter in poor economic situations where the portfolio value goes down and an RMD method is going to be more favorable for them to be able to save their retirement account, if you will. One of the

I think things that that brings to light is it seems like if you're going to go with the substantially equal periodic payments, especially with one of the more aggressive methodologies for calculating the distributions, you will want to

invest in a fairly conservative portfolio. Do you have advice or opinions on the types of portfolios that make sense for the funds in these types of accounts? Well, that's a good question, Scott. And as you've heard me say many times before at different BiggerPockets forums and educational sessions, I

I can't give advice or recommendations on behalf of Equity Trust as a directed custodian. That's not something that I do. Here's what I will say, and I could provide education and context around the question, which I think is a very good question, and people need to be thinking about that.

So you have stocks and mutual funds, traditional investments. We talked about that. Well, what if you had alternative investments like real estate, for example? Many of our clients own single family rental properties. They do private money lending, loaning money secured by real estate to other investors, cryptocurrency, investing in real estate syndications and real estate funds, private credit funds. Those are all strategies that our clients utilize.

What if I had a property in my self-directed IRA and it was a 72T IRA? And let's say something happened, rental income wasn't coming in, I had vacancies, and next thing I know, I don't have enough cash to satisfy my SEPP distribution. Well, my first course of action is what? As we talked about, switch from annuitization or amortization to RMD method. Well, what if I already did that or I'm doing the RMD method already?

Option number two is allow the retroactive 10% penalty to come into play. Option number three, and this isn't necessarily in order, but option number three would actually be distribute a portion of that property to me personally. So now I would be in a partnership with my IRA. I personally would own a percentage of that property and my IRA would own a percentage of that property. A lot of people don't think about those types of things. Is it more complex?

Yes, it's more complex, but Scott and Mindy, you've heard me say this how many times on this podcast. It's where complexity lies that oftentimes opportunity thrives. It's not just the rules, but it's the exceptions to the rules. So I think that's something for viewers to think about in terms of their investment strategy with a 72T IRA. What do I want to be doing with that IRA?

And for somebody that is looking at, well, just putting it in stocks and mutual funds, if you're good at that and you feel confident in stocks and mutual funds, okay, I wouldn't see an issue with that. But if you're somebody that has more confidence in real estate and private equity and alternative investments, why not look at it from that approach? A good friend of mine and tax attorney always says,

Don't allow the tax tail to wag the economic dog. And so I couldn't encourage listeners more to think about it objectively through your own lens and not what maybe someone just says in a broad stroke, well, 72Ts aren't really good for real estate IRAs. Well, it's not necessarily the case. It depends on the investor and how productive and how their performance is as a real estate entrepreneur. Okay, I have several questions. Is there a calculation method that is effective

better for early retirees or is it really just personal preference? So looking at early retirees, so someone that is maybe like 35 years old, is that what you're asking, Mindy? Yeah, like way early, not just like 50. Yeah. So with someone that's 35 years old, let's say,

And let's say they leave their job and they are absolutely reliant. They're solely reliant on their IRA. Like maybe they had a 401k and they had maybe a defined benefit plan. They got maybe an employee stock option plan. And let's say they had like $10 million in their traditional IRA because that's where all their wealth came from.

Well, what's that person going to do? They need to live off of something, right? They probably want to maintain their same lifestyle that they're used to. That person might end up just needing to do the annuitization or amortization method so they can get the most amount of money out of that account every single year while avoiding the 10% penalty. Now, let's say the 35-year-old, they have a million dollars in their traditional IRA.

and they have maybe property investments, they have a Roth IRA that they can start to tap into that. We'll talk about that I'm sure in a little bit. Well, that person might just do the RMD method because they just don't need as much from that traditional IRA.

Just remember, the earlier you are in your life, when you start taking money out of this traditional IRA, you have to ask yourself the question, am I going to outlive that retirement account or is that retirement account going to outlive me? And when you're much younger and you start taking these SEPP distributions,

from the annuitization or amortization method, the chances of you getting all that money out before maybe even your 59 and a half or that much greater, and you have less money in there to be able to compound tax deferred going forward. So that's something that I think folks really need to be cautious of. Now, like we talked about, let's say the 35-year-old starts with the amortization or annuitization, and then 10 years go by and they say, you know what, I'm going to switch to the RMD method because I really don't need as much.

Switch to the RMD method. You got that once in your life. And now you really ratchet down those SEPP distributions. Okay, let's say that I have this big bubble of pre-tax accounts and I have carved off a little bit for my 72T IRA. And then the market goes significantly down. Can I add more into that 72T IRA so that I have enough money to fund? Or is it...

kind of a moot point because it's only based on what happened with your balance last year. I'm just I'm worried for like a really big drop and then you don't have enough money to pull that money out, even though it was in your intention to do it. And you want to avoid that 10 percent penalty. Yeah, you're certainly going to run into a predicament there. And you bring up a good point, which is

You want to think about liquidity within your 72T IRA, right? How much liquidity do you have? Now, liquidity could just be in the form of cash. Maybe you have rental properties in there and you have enough cash built up. Maybe you're doing private money lending, but you have enough cash built up.

If you're invested in traditional assets, maybe that means you need to look at having a more liquid type investment product in there. So you'd want to talk to your financial advisor, financial planner, and talk about a product that maybe isn't going to go down in value when the market goes down in value, if the market goes down in value. So you want to make sure you have some liquidity in there to satisfy these distributions.

Okay. And is there any type of investment that you cannot hold in your 72T IRA? So your 72T IRA is going to be governed by the same rules as any other IRA from a prohibited transaction perspective or assets that you're not permitted to invest in.

So under Section 4975, prohibited transactions, disqualified persons cannot transact with your IRA. So things like I couldn't buy a house from myself with my IRA. I couldn't buy a house with my IRA and live in it myself personally. I can't invest in life insurance policies, collectibles. So like artwork is not permitted in an IRA.

So the tax code does define certain transactions that would be considered prohibited. And the rules would be the same in your 72T IRA as they would any other IRA. In practice, I have only met one person out of all the time I've been doing this that has taken a 72T or SEPP under the age of, let's call it 50. I think this guy was 47 when we maybe started taking them at 45.

And we actually titled the episode Dude Actually Withdrawals Early from His 401k to Support Early Retirement because it's so rare in our experience in there. You deal with IRAs all the time and specifically self-directed IRAs over at Equity Trust.

Do you see a lot of folks employing this strategy under the age of 50, or is it exceptionally rare, even among the cohort of people who have these advanced self-directed strategies?

So in my experience, I don't see a lot of folks under the age of 45 deploying this strategy. And that's not necessarily a mathematical equation or reasoning. It's more or less because when do people, generally speaking, consider early retirement? And that could be because of their occupation, or it could just be because they've now built up enough wealth, right?

Generally, the sweet spot, if you will, I see is between, like you said, 47, 47 and early 50s. Because see, once you get to 55, at that point, you're only a few years away, right, from 59 and a half. So usually folks find other ways to do it. But we see a lot of people that are in their, call it early 50s, that are deploying this strategy because they might have eight or nine years before they can start taking distributions without a 10% penalty.

But they could start doing this 72T SEPP withdrawal strategy. And they're only on the hook to do that for how many years? Well, until they're 59 and a half. Whereas the 30 year old is on the hook for doing it. How long? 30 years because they have to do it all the way until they're the age of 59 and a half. So a lot of folks, again, in the early 50s is what I see happening.

And then, of course, there's a whole population of people that have Roth IRAs and Roth 401ks, which is a completely separate set of exceptions, which can introduce the potential for someone to say, hey, you know what? I'm not going to do a 72T SEPP distribution for my traditional. Instead, I'm going to start taking money out of my Roth. And when you do...

take money out of your Roth, that's not a 72T withdrawal. That's just a regular old withdrawal because it's a Roth. You already paid the tax on it, right? That's correct. Then we get into what we call the ordering rules or the untechnical version. I like to call it the Roth IRA layered cake approach. Let's get into that. I just want to make one more observation before we start talking about Roths and the early withdrawal strategies there.

All of this, every part of this discussion for SEPP, substantially equal periodic payments or 72T, all these different names mean the same thing to confuse folks specifically. That's what we like to do here on BiggerPocketsMoney. All of it though is again discussing pre-tax retirement accounts, the 401k or its traditional pre-tax equivalents, right? For all the different tools that we've discussed here at length on BiggerPocketsMoney over the years.

But most people under the age of, let's call it 35, are unlikely to develop an enormous amount of wealth in these variables. I mean, you will find them. There are exceptions, but you have to have a huge income to be able to put money into these things, do these strategies like backdoor, mega backdoor Roths, and get excellent returns in order to have, you

you know, mid six or million plus dollar portfolios in your early thirties, for example. So I think it's another component that's impacting this and why you see that sweet spot probably in the 45 to early fifties range as the vast majority of people who actually employ the substantially equal periodic payment strategy. You're right, Scott. Let's say someone has a lot of assets, not in retirement accounts, properties,

stock portfolios, brokerage accounts, cash accounts, CDs, business assets, right? They have assets outside of their IRA. They're probably going to start there, right? That's how they're going to satisfy their early retirement. And then they'll reserve their traditional IRA until they're the age of 59 and a half because they don't need to go through this SEPP distribution.

If you think about it, what's the theory behind this? Why in the world does this law even exist? It's not by accident, by the way. It was done very purposely and intentionally. It was done because the IRS and the government, I will say Congress in particular, recognize that some people don't work till they're 59 and a half. Like, for example, firefighters and police officers, most of them retire when? Early 50s, right? And so they wanted to give relief to the taxpayer that retires early.

And the SEPP distribution allows them to do that. For someone that has most of their wealth in a traditional IRA, this can be a really good option for them. But again, most people are going to start with their other assets across other accounts. John, what does taking a distribution actually mean? You're selling equities that are held in this 72T IRA, right? Or investments held in this 72T.

IRA, right? That's correct. So let's say someone just has a stock mutual fund ETF type portfolio, traditional investments. They don't have real estate and loans and everything that we talk about in other episodes, right?

And so step one for that individual is to put in a liquidation request with their advisor, planner, broker, right? So they liquidate whatever positions necessary, which is going to give them the amount that they have to distribute for that year. So using our example earlier of someone with 500,000 under the required minimum distribution method, method number one,

the total amount at the age of 50 that they would have to distribute dividing the balance of the previous year on December 31 by the life expectancy factor using the single life expectancy table, that comes out to be about 14,000. So the $500,000 account, the individual would liquidate about $14,000 in positions. Now, maybe they have some liquid cash in there already, so easy enough. They then go to their custodian. So whatever financial institution

has their IRA, they go to that custodian and they request a distribution. It's just a simple distribution. For example, here at Equity Trust, they just go into their account online and say, I want to take a $14,000 distribution.

Now, some custodians have the apparatus where the taxpayer would actually say, hey, this is a 72T SEPP distribution. And there's a special tax code that goes into the 1099R when this happens. And that basically tells the IRS that this was a 72T distribution. Now, if your custodian is not doing that, which is not uncommon, by the way, many custodians don't do it.

What the taxpayer would then do is work with their tax advisor, their tax preparer, and most likely they'll be filing IRS Form 5329. So with their tax return, they would file this form.

IRS form 5329 with their 1040, and they would deem that distribution a distribution with an exception. So now you're telling the IRS, hey, I took a distribution. I'm being honest here. IRS, I took a distribution. I'm under 59 and a half. I know usually that's bad, but guess what?

Under 72T2A, Roman numeral four, I meet an exception because I ran the appropriate calculation. I'm doing it consistently with accuracy, accurately, and this is considered an SEPP distribution. And I effectively do have to pay taxes. So that amount is added to my ordinary income in that year and I pay taxes, but no 10% penalty.

This entire amount gets taxed just as income. There's no complicated formulas for like how much you paid for the investment and the capital gain and all of that. It's just straight income, that $14,000 that we're talking about. That's correct. That's the great thing about traditional IRAs. IRAs in general, they're tax exempt entities. So basis of stocks and mutual funds is irrelevant. There's no capital gains where you have to calculate what's capital gains, what's interest income, what's ordinary income. There's none of that.

All of the income goes into the traditional IRA from the sale of those stocks, mutual funds, real estate, whatever. And then when you take a distribution, whatever amount you've distributed is added to your ordinary income. And it works the same if you're 59 and a half or older. Whatever amount you distribute just gets added to your ordinary income and you pay taxes accordingly. Can you do a 72T if you're still working? Like if you just have

rather low income or you want to just start accessing those? Or do you have to be retired in order to do a 72T? You could still be working. You could still be contributing to IRAs and 401ks. Nothing's going to stop you from doing that. A great example is I work with a lot of real estate investors. They retire and they become real estate agents, for example.

And now they have some income. Maybe it's not a lot of income, but they have income. And so now what those people do is they open up a solo 401k plan. They open up a solo 401k plan. They start deferring some of their commissions, their net self-employment earnings into the solo 401k plan and potentially getting that into the Roth bucket of the plan using something I call the mega backdoor contribution, getting way ahead of myself here, guys. But

But the point I'm making is if they wanted to start taking these SEPP distributions from their traditional account, they could absolutely do that while also having a solo 401k plan. So still working and still taking these distributions. Of course, of course, if this person that we're talking about here,

is a real estate investor on top of being a real estate professional, deferring some of those ordinary income gains into the solo 401k. They can at the same time be buying real estate, depreciating it, taking losses and paying no taxes on their substantially equal period of payments or better yet doing backdoor Roth conversions, which we're going to get to another episode with John and talk about all the fun strategies there. I presume that's one

slice of the Roth layer cake that you've previewed with us. You nailed it, Scott. Now what you're talking about is what we call the Venn diagram, where we start bringing in our taxable world and we start looking at it holistically with our tax-free world.

And this is why I love CPAs out there, for example, like Amanda Hahn, right, who I understand is very active in the BiggerPockets community, understands this, understands that Venn diagram, whereas a lot of tax strategists out there only look at one or the other. Instead, you look at both. And I think what you just described there, Scott, is exactly what we're talking about in terms of that Venn diagram. Okay, well, I'm glad you brought that up, Scott.

And John, you said the solo 401k. I'm like, well, I've got one of those. And Scott's like, and you could be a rep status. Oh my goodness. I have not traditionally qualified, but I also haven't tried. This could be...

This could be very, very interesting. I'm excited for this. I mean, this is just a 72T layer cake, too. If you can keep your tax, like the whole point, the whole problem with the SEP, we talked about this, but we haven't really illustrated it, is it's ordinary income. You're distributing from a traditional pre-tax retirement account and it's hitting your income.

your tax form as ordinary income. And if you are a high earner or you go on to build significant wealth and you're in a high relative tax bracket, that could be taxed at, you know, up to, depending on how wealthy you are, 43.5%, depending on what state you're in. And that's not very good use of that marginal dollar if you're up there.

But if you have low income, then this is a very powerful tool. For example, if you have a couple of rental properties and they're producing no or maybe even a loss on there, or if you have rep status and you're able to do accelerated depreciation and those types of things and declare a loss, you could pay no tax.

on these distributions whatsoever. And that's that next leg of planning there and where we would love to layer in the real estate component with all this stuff or other ways. Real estate's my favorite because of the really fun games you can play to...

do as little of your part in contributing to the national deficit as possible. Yeah, Scott, you're right. Taking passive losses to offset active income if you meet that specific designation. And that's where the individual investor should be working with their tax advisor and talking about these types of things, sharing this podcast with them so that they understand. Most tax advisors are going to understand the basic concepts of SEPP distributions and

But in terms of how that plays in with their overall tax strategy, with passive losses possibly offsetting their active income, that might be a little bit different. So it's up to the investor, the onus is on the investor, to communicate that to their tax advisor to talk about this and do some more what I'll call deep planning. Now, you maybe think of something, Scott, Roth IRAs. Why would someone do these 72T distributions, these SEPP distributions, instead

instead of just taking from their Roth IRA. Well, here's a reason why. My Roth IRA is incredibly powerful, compounding interest in the absence of taxation. And maybe I'm a really good real estate investor. I'm just saying this hypothetically, right? Maybe I'm a really good real estate investor. My returns are substantial and I want those to be tax-free in my Roth. So I don't want to take money out of my Roth. I would rather take it out of my pre-tax account that's going to be taxed anyways.

The last thing that I'll mention is some people don't want to take money out of their traditional IRA because they were getting deductions for it their entire life. And when they turn 73, which is now the required minimum distribution age, we'll turn to 75 once 2033 rolls around under Secure Act 2.0.

These requirement of distributions are required. They are what they are. You've got to start taking money out once you get to a certain age from a traditional account. Roth IRAs don't have this. You don't have to take RMDs during your lifetime, but traditional accounts do. Now, of course, we have exceptions, right? Mindy, we love exceptions. We started this whole thing with exceptions.

So there's an exception to the RMD and paying taxes on it. You still have to take the RMD, but you don't have to pay taxes on it. How do you do that? Qualified charitable distribution, QCD for short. This year, it's up to $105,000. You can distribute from the traditional, give away to a charity if you're charitably inclined anyways, and not pay any taxes. Couldn't you also just charitably contribute whatever your distribution was?

So, you know, you have $100,000 in distributions and required minimum distribution. You donate $100,000 completely offsets it, too, right? It might work. But generally speaking, what people are trying to do is also from a tax accounting perspective, just simplify it is when you take a QCD distribution from your custodian, you actually indicate it's a QCD distribution and it goes directly to the charity.

And so that most people are going to do it that way. I suppose you might have some logic there, but we'd have to think through some of the nuances. Yeah. So I love that we're ending on this component here because I think another way of restating what you're saying, John, is as interesting and as powerful as the tool that you just discussed with us for an hour here, the substantially equal periodic payment, the 72T rule, SEPP.

as powerful as that is, it's really one tool in the arsenal. And the real strategy, I think, that we all are kind of like beginning to circle around here is, can you take that pre-tax dollars and get it into a Roth? Because the Roth is really the holy grail of the retirement planning situation here because it grows tax-free. And it's like, at least for me, I believe that tax rates are going to go up.

And that's got to impact the money in 401ks. You know the government's going to go after that at some point in the next 50 years. It's just almost a given for me in that capacity. But the Roth would be a total renege. It's truly tax-free growth forever, or at least I believe that. That would be a true revolt from a lot of people if –

If the Roth begins getting subject to taxes. And so I think that's a core component of this very long-term bet that

People may disagree with or agree with, but that guides my thought process. Congress has passed many different laws over the years. It started really in 2006 and even as late as the 2020s here has passed laws that really encourage, I don't want to say encourage people, but it creates more ease for people to convert from traditional to Roth.

So what you're talking about there is saying, hey, this traditional account, I'm in partnership with the IRS. The reality is, is you put in all the money, you do all the work, you take on all the risk and they get a percentage of it. And guess what? That percentage changes. You might agree to one percentage today and next thing you know, your tax rate is different down the road. And you have to give that to the IRS when you distribute. Right. We talked about that. But could you, if you will, buy out your partner now?

Could you buy out the silent partner now? You absolutely could. That's a Roth conversion. Convert from a traditional IRA to a Roth IRA. When you convert, there's no 10% penalty.

but you do have to pay taxes when you convert that amount. So if I have a $200,000 IRA and I convert 200,000, $200,000 is added to my ordinary income and I'm paying taxes. Now, maybe you get with your tax advisor, you qualify for professional real estate status, like you said, Scott, maybe there's some ways to offset that, but the reality is, is the tax is the tax.

Now, you don't have to convert all of your money. You could convert just a portion of it. So maybe you convert $100,000 out of the $200,000. Maybe you convert over multiple years. We call this converting in stages. So maybe you convert $50,000, $50,000, $50,000, and you kind of spread that out over multiple years so that you can lessen your tax burden. Love it.

Love it. That's the real prize there. And again, the rep status, you buy a property, you cost SIGIT, and you get a $100,000, $200,000 loss in that year, for example. That's a really powerful way to knock over $200,000 or a little bit more up to a very low income, low marginal tax bracket in that conversion process. All right. Last question for me here. Mechanically,

I just heard this episode. What do I type into Google to begin the mechanics of actually setting this up? I've got a IRA, Swiss Schwab, whatever it is, right? Or equity trust, if it's a self-directed one.

I want to begin taking out these distributions. Is there a form? What do I Google? There are some calculations out there. I will say if you just type into Google SEPP withdrawals IRS, you're going to go directly to the IRS webpage that actually breaks down the three different methods, RMD, amortization, annuitization.

There are, if you look on YouTube, there are actually some pretty good videos that will walk you through the formulas that you would put into an Excel spreadsheet. What I would encourage folks to do is if they have a tax advisor to work with them, if they don't find a tax advisor and create a spreadsheet and on three different tabs, have your three different methods, RMD, amortization, annuitization.

And then start to look at how much do you need on a monthly basis if you're going to do this. And then that would help you determine, okay, how much do you want to make your 72T IRA? If you have a million dollar IRA, but you don't need to base your calculation on the full 1 million, we talked about breaking that out into a separate IRA. So start to run your numbers to determine, okay,

okay, how much do I need and which method is going to be the best method? Where's your spreadsheet? Can people can people download this link somewhere? So that's an interesting question. I have my spreadsheet. As you know, Scott, representing Equity Trust, we we can't give legal advice or tax advice. So it's not something that I could I could share because it could potentially be viewed as a tool that would be offering tax advice.

But I will tell you, there are some tools out there. And I also encourage folks, you don't have to be a mathematics wizard. You don't have to know how to use a, what was it, the Texas Instruments, like BI, whatever, time value money calculator, whatever.

You don't have to be an expert at this. The formulas are pretty straightforward. You can find this information and run these calculations on your own in a Google Sheets document. And documentation is important. You know, having the documentation of what you're doing, what the amount is of your distribution, and making sure you adhere to that on an annual basis, and make sure that your tax preparer understands what you're doing so that they can file your returns appropriately.

I just remember that brings me back to those days when I was told you won't always have a calculator in your pocket growing up. You were told that too, Scott?

Scott? John, this has been fantastic. Just an absolute masterclass on this subject. Thank you so much. You, you are, it is really impressive to just talk to somebody who is just so thoroughly mastered the subject matter. And so clearly answered these questions, gotten them all. Uh, and you know, even, even the one, the one brand new one that you never got before, you're able to, to, to handle right there on the spot. It's truly impressive. It's a privilege to be able to work with you. And, uh, and, uh, uh,

and learn from you on these subjects. Could you tell us a little bit more about Equity Trust and where people can find out more about self-directed IRAs before we go? Yeah, so our firm, Equity Trust, as a custodian, when you think of custodians,

Most custodians only allow you to hold stocks, mutual funds, traditional investments. But as an alternative asset custodian, we allow investors to hold real estate, private equity, cryptocurrency, private credit funds.

We have a lot of real estate investors and have always had a lot of real estate investors. And that's a big part of why we do so much work with Scott, you and Mindy and the BiggerPockets community. We have a lot of folks that come to us from the BiggerPockets community because they want to invest their retirement dollars into real estate instead of traditional stocks, bonds and mutual funds.

or it's a diversification strategy for them. They don't want 100% of their portfolio subject to the risks associated with the stock market. They want to invest in real estate. And so that's what we do as a firm. We've been doing it for a really long time. Our company founder, Dick Desich, he's known as the pioneer of the industry. He started the predecessor to Equity Trust back in 1974.

In the early 80s, he began helping investors invest in real estate with their IRAs and has since grown the company to over 500 associates, over $66 billion in assets under custody and administration per this date of this recording. And I've been with the firm for nearly 20 years. I'm really passionate about working with real estate investors and entrepreneurs.

And I love talking about the tax strategy side of what we do and how to help investors from an educational perspective. So like Mindy, I know that you're really passionate about it too. And Scott, you are. The exceptions to the exception or the exceptions to the exception to the exception of the rules and where the opportunities exist for investors and not just the opportunities, but I think the practical opportunities, the reasonable and practical opportunities.

Our website, easy to find us. Just search us online, Equity Trust Company. And we have a whole YouTube channel just like you guys do. I don't think we get as many views as you do, but we'll try our best. And a lot of content there that folks can bite into. Yeah, wealth of information and you produce most of it. And it's just, again, it's amazing how well versed you are in this item here. John, thank you so much for coming on BiggerPocketsMoney. Again, we'll have you back soon to talk about

the roth layer cake uh which i'm very excited to uh uh oh there's a cheesy line yeah gobble up uh uh next time so i love it looking forward to it scott thank you

John, thank you so much. And we'll talk to you soon. That was John Bowen from Equity Trust. And that was absolutely fabulous. I mean, I didn't know how much I didn't know about 72Ts. And now I have a whole bunch of rabbit holes to go down with that rep status and the passive losses and paying no income tax potentially on my withdrawals, even though I'm supposed to. But I'm doing it through all of these exceptions, not loopholes. We're not...

we're not doing anything wrong. We're just using exceptions to the rules. So thank you, Scott, for the hours of research that you have just given me as homework. What do you think of the episode? I think John is just an absolute master at this. I think it's going to be hard to find a

a guest or person who is more well-versed in the intricacies of retirement accounts, including the basics here, the basics now of accessing retirement accounts early and how that interplays with traditional versus

Roth versus self-directed versus your standard boilerplate 401k or Roth IRA accounts. So it's just a privilege to learn from him. And I think I want to zoom back out though and rehash that point. We spent a lot of time today talking about the substantially equal periodic payment

72 T approach here. And I, again, believe that that's a niche strategy for people in their, again, mid to late forties, early fifties that want to withdraw from pre-tax retirement accounts early. And that this is a, you know, as you think about this, this is one tool in the arsenal to

great episode. It's a great piece of content and a great framework to have as an option available to most. But I think few will actually use this. And it's a building block and an option in the pursuit of what I think is the holy grail for retirement accounts of getting everything into a Roth.

and having that available as soon as you reach 59 and a half. Because I, again, fundamentally believe that tax rates will go up on Americans over the next few decades and that we will all want that money in a Roth eventually. The path to getting there can either be a direct contribution to a Roth if you're a low income earner today or a contribution, maxing out contributions to traditional retirement accounts and finding that conversion strategy later. And I look forward to diving into that with him in even more detail next time.

Yes, I am super excited to talk about that Roth layer cake. We didn't have time to get into that today. It's a bit of a different, same but different topic. So we wanted to separate that out into its very own episode. So that'll come out in just a few weeks.

But I am so excited for this episode. I'm going to go back and listen to it with a pen in my hand just so I can take more notes because I couldn't type and ask questions at the same time. All right, Scott, should we get out of here? Let's do it. That wraps up this fantastic episode of the BiggerPocketsMoney podcast. He is Scott Trench. I am Mindy Jensen saying later, skater.