The 3 Most Common 72(t) Mistakes That Trigger IRS Penalties

By Robert Townend, CPA, Early Retirement Access

A 72(t) plan, also known as a SEPP plan, substantially equal periodic payments, is a powerful tool to access deferred retirement funds (401(k)s, IRAs, 403bs, TSPs) before age 59 1⁄2 without paying the 10% early distribution penalty. For someone retiring early, leaving a corporate or government job, or needing structured income before traditional retirement age, it can provide a reliable bridge.

But the rules are unforgiving of 72(t) mistakes.

The Cost of Getting It Wrong

A 72(t) plan is not simply “take money from your IRA early, and it’s exempt.” The IRS allows the penalty exception only if the withdrawals follow a very specific structure. If the plan is modified in any way after it starts, the taxpayer may owe the 10% penalty retroactively on all prior distributions that were treated as penalty-free, plus interest. For example, if you have $60,000 distributions for 8 years until you turn 59 ½, you could face up to a $48,000 penalty plus interest, which could total upwards of $68,000! The IRS explains that substantially equal periodic payments are an exception to the 10% additional tax, but the series must comply with the 72(t) rules.

At Early Retirement Access, we are routinely contacted by taxpayers who have made 72(t) mistakes resulting in plan modifications. Often, by the time the 72t mistake has been discovered, the plan is already considered “modified” under section 72(t) of the Internal Revenue Code, subjecting all distributions made to a 10% surtax, plus interest and penalties.

Three of the most common 72t mistakes we see:

1. Miscommunication with your IRA custodian (Fidelity, Schwab, Vanguard)

This can best be summarized in a single sentence:  If you're starting your SEPP plan, the custodian does not have your back.

Your Custodian may help process the distributions, issue the Form 1099-R, and in some cases provide 72(t)/SEPP educational material or forms, or even help with the calculation; however, the taxpayer owns the 72(t) compliance risk, not Fidelity, Schwab, Vanguard, etc. Their own websites make this point very clear for people considering a 72(t) with language in the fine print to “consult a tax advisor” and “It is your responsibility to ensure that your withdrawals comply with IRS rules and deadlines.” 

Miscommunication with your custodian can and does happen, and in those cases where mistakes result, the IRS will look to the taxpayer. All custodians, preparers, and CPAs are essentially regarded as 3rd party consultants by the IRS. 

I recently talked to a taxpayer who had taken out a 72(t) while working with a financial advisor at a major brokerage firm/custodian. A 72(t) SEPP plan was calculated from the client's IRA that included $750k in retirement assets. Before the first distribution, the assets were separated into a conservative withdrawal sleeve and a broker-managed growth sleeve. SEPP distributions were subsequently calculated off the original account balance, resulting in a broken or “modified” SEPP. The custodian’s position was that only the conservative IRA was part of the SEPP structure, and the taxpayer was in error.

2. Over-complicating the 72(t) SEPP Plan

One of the most common ways taxpayers create problems with a 72(t) plan is by making the plan more complicated than it needs to be.

A SEPP plan should be designed as simply as possible, documented clearly, and made as easy as possible to monitor. The adage “measure twice, cut once” comes to mind while building a SEPP.   Once the plan begins, the taxpayer must take the correct distribution amount each year for the longer of five years or until age 59 1⁄2. Because the rules are rigid, the best plans are often the cleanest ones: one clearly identified account, one documented calculation, one annual distribution target, and one repeatable payment process.

Problems often start when taxpayers try to add too many moving parts. A common mistake is setting up multiple distributions from your SEPP to an after-tax account instead of just one, and also setting up distributions to third-party accounts outside of your control. In both cases, these complicate your SEPP plan, increasing the possibility of errors over a SEPP plan's life that often spans decades.   

3. SEPP Plan Distribution Mistakes

Distribution errors are probably the easiest way to break a 72(t) SEPP plan.

A SEPP plan depends on taking the correct annual distribution amount. Once the calculation is established, the taxpayer needs to withdraw that exact amount each year for the required life of the SEPP plan. 

One mistake we’ve seen is taking in-kind distributions from the SEPP account. Often, if an IRA under a SEPP plan includes company stock and the taxpayer can’t or doesn’t want to sell it first, they make this mistake.

An in-kind distribution means the taxpayer transfers an investment itself, such as shares of stock, mutual funds, or ETFs, out of the IRA instead of selling the investment and distributing cash. This creates a problem in an SEPP plan because the value of the asset transferred doesn’t exactly match the required annual distribution. 

This leads to an important point: while IRC does not prohibit certain IRA investments (e.g., annuities, CDs), they may not be appropriate for a 72(t) SEPP plan. Cash is king in a SEPP account, at least enough to make the distribution from your SEPP into an after-tax account.

Another common mistake we see is over-reliance on automated distributions. Automation can be helpful, but automation should never be treated as a substitute for an annual review. In cases where taxpayers have chosen to automate a distribution, we’ve seen instances where a custodian processes a payment incorrectly, skips a payment, changes a payment date, or fails to distribute funds if there is not enough cash available in the account. If the IRA is fully invested, the safest approach is to treat distributions as an annual compliance item, not a set-it-and-forget-it process. 

Get Professional Help & Avoid Penalties

A 72(t) SEPP plan can be an effective early retirement income strategy, but it requires precision. Most 72(t) mistakes are avoidable: miscommunicating with custodians, overly complex structures or account holdings, and distribution errors.

The goal is not to build the most sophisticated SEPP plan possible. The goal is to build and follow a simple, accurate, and well-documented plan that will be easy to defend if the IRS ever asks questions.

If you're considering a 72(t) SEPP plan, professional guidance can help you avoid costly mistakes and ensure your strategy complies with IRS requirements from day one. Contact Early Retirement Access today to discuss your situation and build a plan designed to support your retirement goals with confidence.