72(t)/SEPP Penalty Free Early IRA Distributions 1 Year Later

September of 2016 I established my 72(t) distributions from my traditional IRA using the amortization method. This was after 8 months in early retirement.  As far as I know, I am the youngest person to do 72(t) distributions, despite being told I’m crazy to attempt this so far away from a traditional retirement.  But hey, nothing I’ve done to this point in my life regarding finance and investments has been traditional and it’s worked for me.  For those not aware of 72(t)/SEPP (substantially equal periodic payments), I suggest reading my most trafficked page to get initiated on the subject.

The plan was to set up the Substantially Equal Periodic Payments in a way that would allow me to only draw from the dividends only and not touch the principal or have to sell stock. Over time, as the dividends increased, I would have more and more of a cash buffer against any dividend cuts in that account, and could actually start to reinvest some of the dividends. The plan also includes eventually switching from the amortization method over to the Required Distribution method as the balances increase/dividend income doubles or more over time.  For more details on the plan click the first hyperlink above.

So here is the one year check in on the SEPP one year later.

Initially when setting up the 72(t)/SEPP, the balance in the related Traditional IRA was sitting at $345,415.12.  Based on the mid term interest rate of 1.71% and life expectancy of 46.5, my SEPP amount came to $10,829.03.  I pro-rated the first year distribution for 4 months, so I took out $3609.68 for year 1 in 2016.  This equated to a withdrawal rate of 3.13%, a rate that was slightly higher than the yield of the portfolio at the time (not taking into account special dividends or cover call option premiums).

Below is the distribution history so far from the account.  Note, I do have 4 more distributions that I have to take out totaling $4000.

Let’s fast forward to one year (today) and see how the account is holding up.  Currently, the balance in that Traditional IRA sits at $372,381.75, representing an increase of 7.80% (nothing spectacular).  Current dividends, due to several nice increases stand at $11,437.95.  This represents a current yield on the portfolio of 3.07% (not including special dividends or covered call premiums). The required distributions from my SEPP sit at an unchanged amount of $10,829.03 under the amortization method.  So after 1 year, I’ve already started to build a little bit of a buffer with respect to dividend income from this particular account vs how much I have to take out in the amount of $608.92.  Not bad of a buffer after just one year (note I am expecting 2 more companies to announce dividends increases in Q4 as well-MSFT and MCD).  I fully expect for this spread between the dividend income and fixed withdrawals to continue to increase every year over time.  In reality, late next year I will also be able to start reinvesting some dividends late in the year.  This reinvesting of dividends gradually over time will have a positive side effect of compounding the difference between dividend income vs SEPP withdrawals.

Side note, factoring back in the withdrawals over the last year of $10,438.71 {(372,381.75+10,438.71)/345,415.12} total return sits at 10.82%, a much more respectable number.

Basically my 72(t) distribution has been set up in such a conservative way that I fully expect to not bust the plan.  In fact, I fully expect to closely double the value of this account within 10 years and consider switching to the Life expectancy method (again read the first hyper link for exact details on the plan).

Needless to say, the 72(t) Distribution is going exactly according to plans.  How is this.  Most financial models ignore the effect of dividends.  They only consider balance fluctuations and develop a withdrawal calculation based on that fluctuating balance.  With my 72(t) plan, I’ve set it up to live off the dividends (not even all of the dividends in fact).  In doing so, I’ve negated the worry of a withdrawal strategy based on a constantly fluctuating balance and gone with a slow and steady/boring approach.

Let’s Talk Taxes…

Last year, I paid $10 in taxes.  It was awesome.  I paid basically no taxes on this 72(t) plan, no taxes on qualified dividends, since I was considered poor by the government.  Had I continued on the same path, the story would have been pretty much the same for 2017.  I have had low living expenses for a while now, so it makes it possible.  So this strategy set me up to get tax deductions during my working years, and pull the money out tax free during my early retirement years.

However, some things did change.  I got bored, want to meet my better half, and went back to work.  How does this 72(t) distribution effect someone who decides to go back to work.  It just gets lumped into my other income.  To offset it, I’m off course maxing out my 401(k), will max out my second traditional ira, and Health Savings Account as well.  With all of those contributions, I hopefully can get down to the 15% tax bracket, so I don’t have to pay taxes on my qualified dividends.

Would I Have Changed Anything…

No, I went back to work this year.  I’m not sure how long I’ll stay continuing to work full time as I hope a part time adjunct position opens up.  In the mean time while I work, the SEPP income is basically getting reinvested in my brokerage account, purchasing dividend paying stocks there.  When I stop working down the road, the SEPP income will be there, but my qualified dividend income will be even higher.  Just because I have gone back to work, does not allow me to stop the distributions, without paying penalties and interest to the IRS, so I will continue to take out the required withdrawals.

So there you go with my 1 year review of my 72(t) distributions.  If you are curious, here are my original projections regarding this plan, showing I’m actually ahead of my projections (I tend to lean on the conservative side on projections) :

What do you guys think?

Follow me on the social medias:

Readers Comments (4)

  1. You answered a very specific question that I had regarding the taxation of dividends within a SEPP. I wasn’t sure if *all* distributions (even dividends) from a SEPP were taxed as “ordinary income”, which is what most resources say.

    But after reading your update, it seems (and please correct me if I’m wrong) that if you receive *only dividends* as your distribution from a SEPP, then the distribution is treated as “dividend income” and not as “ordinary income”. Is this correct?

    • No, not correct Justin. Any distribution from a traditional ira will be taxed as ordinary income (dividends or principal).
      There’s a different brokerage account with dividend paying stocks that I have (not an IRA)… those dividends are taxed at 15% as qualified dividends. However, for people who are in the 10 or 15% tax bracket, they don’t pay taxes on qualified dividends as the current IRS rules stand.
      So I have a couple moving parts in this post. I set up my 72(t) to only draw from the dividends, with the idea I don’t want to ever touch the principal until later. Because of the ordinary income level I fall in when taking into account exemptions and standard deductions, I practically pay no income tax on this. Also, because of my tax bracket (again the 10 or 15%), I don’t pay taxes on my qualified dividends from the brokerage account. Check out a post about “how I pay no taxes in early retirement”. Hope this helps. Let me know if you have any other questions. Also there are other posts on my site about 72(t)/SEPP

      • Thank you for the clarification.

        One more question…what if an early retiree (in their 30s/40s) has a large IRA balance and wants to take out *more* than is indicated by the various methods used to calculate the SEPP withdrawals?

        Is it possible to access these additional IRA funds via SEPP without incurring penalties or taxes?

        • No. You have to use one of the 3 approved methods (life expectancy, amortization, or annuitization) and take out that specific calculated amount each year. Amortization and annuitization produce a fixed dollar amount you have to take out each year. Life expectancy method produces a varying amount based on account balance divided by the IRS life expectancy chart found in Pub 590. Generally the life expectancy method produces a lot lower amount for a super early retiree. You can start out your SEPP using the amortization or annuitization method and make a 1 time change later on to the life expectancy method (BUT NOT VICA VERSA). That is actually my plan.

          Taking out a different amount at any time you establish a SEPP (or failure to take out) results in busting your plan. That means you owe the 10% penalty on ALL distributions (prior years included) plus interest.

          If you need additional funds over and above the SEPP amount, that’s where taxable brokerage accounts come into play or even looking at taking out the principal from a Roth IRA, or even doing a part time job.

          Check out the hyperlinks in this article, a few of those go into great details on 72(t)/SEPP.

          Thanks for checking out the site. Let me know if you have additional questions.

Leave a comment

Your email address will not be published.


*


Follow me on the social medias: