Financial Planning, Millennials

How To Use Your 401(k) Before Age 59.5

“Don’t contribute to your 401(k), that money will be locked up till you are at least 59.5.”

I am guessing all of you have heard this by now… And It’s funny, the people who give this advice are normally selling a different product.


Anyways, here’s why it’s wrong. For those that do not know, your 401(k) is a pre-tax retirement account. This means the contributions you make reduce your taxable income today and then when you pull the money out in retirement you will pay taxes on it. But, you have no taxes between now and then as it get’s invested and grows. Plus many 401(k)’s come with a match. For example, your employer may offer a 100% match to 3%, meaning if you put in 3% of your income, they will put the same amount into your 401(k). It’s nice to get free money, right? (Also most have a ROTH 401(k) option where you can use post tax dollars).

Anyways, nearly every time someone does not use a 401(K) it’s because they are scared of it being “locked up,” but these people are not fully educated on the rules of a 401(k). They think that the only way to get money out before 59.5 is to take a 10% penalty, which is not true thanks to Rule 72(t).

What Is Rule 72(t)?

Rule 72(t) refers to a section of the Internal Revenue Code that outlines the process of making early withdrawals from certain qualified retirement accounts without paying extra penalties. It’s important to note that if you have a permanent disability, some medical expenses, inheritance, a first-time home purchase or college tuition payments then you can take the money out without a 10% penalty. However, if none of those apply, then rule 72(t) helps you get money out without the penalty.

Rule 72(t) basically lets you establish a schedule of annual (or more frequent) withdrawals from your retirement account called SEPPs. SEPPs means substantially equal periodic payments.

If you choose to withdraw money from a qualified account, like a 401k, before 59.5 then the funds are distributed to you as SEPPs. These regular payments are made over the course of five years or until you turn 59 ½. Note: You have to carry them into your 60s if you started later.

Here are some rules you need to know to make this work:

1. You must schedule annual withdrawals, at a minimum.

You can schedule several SEPP installments a year, if you like, but you must take at least one a year for five years, or until you turn 59 ½ whichever is later. If you miss even a single payment, you’ll owe the IRS early withdrawal penalties on all funds you’ve already taken out under your SEPP plan.

2. You must pay income taxes on money that’s never been taxed.

That includes any contributions and earnings in your retirement account (just like any other time you pull from a pre-tax account).

3. You cannot withdraw funds from an account managed by an employer you’re still working for.

Retirement accounts at your present job are not eligible for SEPPs.

Please be cautious when using Rule 72(t). If you make any mistakes then you will owe a 10% penalty. This is why you should work with an advisor to execute this strategy!

There gets to be a lot more confusion with rule 72(T) as you try and figure out what the SEPPs are, the amount to take out, etc. For this post, we will not get into that I just wanted to explain why and how you can take funds out early, rule 72(t), and the big rules around it.

Disclaimer: Consult your financial advisor and CPA before determining if this strategy is right for you!