Outside-the-box Idea: Using 72(t) to make an "asset transfer"

For those who have most of their savings in tax-deferred retirement accounts, but are intrigued by the idea of buying a retirement home now, there may be a tax-effective way to execute the transaction. Internal Revenue Code IRC Section 72(t) allows individuals to access their IRA accounts penalty-free at any time if the withdrawals are taken as a series of substantially equal periodic payments over the life of the participant. This means you can begin drawing a regular stream of “retirement income” from your IRA at any age. While the income received is taxable, no additional penalty tax is applied.

In order to be considered “substantially equal periodic payments,” the distributions must meet the following criteria:

  • Withdrawals must be on a regular basis, most often monthly, and at least annually.
  • Withdrawals must conform to one of three IRS approved calculation methods.
  • Withdrawals must continue for at least five years or until you reach 59½, whichever is longer.

Depending on the size of your IRA and the cost of the property, these monthly distributions could be used to make the mortgage payment on the vacation home. For many individuals, the additional IRA income may largely be offset by the tax deduction for the additional mortgage interest paid, especially in the early years of the mortgage. The end tax result: more taxable income to report, but also more tax deductions.  By spending some of the IRA now, you lose the growth that could have occurred if the money had stayed in the account. But in this example, the IRA distributions are being used to build equity in the new home. Overall, your net worth is still growing, only the growth is in home equity instead of the IRA. And instead of delaying gratification, there’s some immediate enjoyment.

Note: Not all tax-deferred retirement plans allow for 72(t)-type distributions. Additionally, the calculations required to be sure this “early retirement income” conforms to the law are complex. Do not attempt a distribution of this type without seeking some expert assistance.

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One Response to Outside-the-box Idea: Using 72(t) to make an "asset transfer"

  1. Tax Lawyer says:

    I’ve been engaged in taxes for lengthier then I care to acknowledge, both on the personal side (all my employed life history!!) and from a legal viewpoint since passing the bar and following up on tax law. I’ve put up a lot of advice and corrected a lot of wrongs, and I must say that what you’ve put up makes impeccable sense. Please uphold the good work – the more people know the better they’ll be outfitted to handle with the tax man, and that’s what it’s all about.

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