IRA Hacks: 72(t) and the Spousal IRA

Two little-known ways of using IRAs can be useful to early retirees or potential early retirees, stay-at-home parents, or anyone who’s not working but has a working spouse.

[Disclaimer: The following should not be considered financial advice. I have only a rudimentary knowledge on these subjects. Comments and corrections are appreciated.]

The “Spousal IRA”

In order to contribute to an IRA, your qualifying income for that tax year must be equal to or greater than your IRA contributions. So if you earned $3,000 in 2007, you could not contribute the maximum of $5,000 to your IRA. But if you’re married and your spouse is working, your spouse can contribute to your IRA up to the maximum.

This is occasionally referred to as a “spousal IRA,” but it’s not a separate type of account. If you already have an IRA from your working years, your spouse can contribute to that account, and if you need to open up a new account for this, it’s simply a regular IRA account. You must file your taxes jointly.

The most obvious use for this is so that stay-at-home parents can save for retirement. But I can also see this type of contribution being helpful for couples with a whole spectrum of other situations--couples in which one partner has retired early, is making only minimal income from a part-time job, is trying to start a new business (but not making a profit yet), or is unemployed/taking some time off. It allows a married couple to take full advantage of the perks of IRAs even though one of them may not have a job.

The 72(t) Rule

I don’t know why the 72(t) rule isn’t better-known. Even in the online early retirement community, people don’t seem to talk about it much. I think it’s so cool I can hardly believe it’s real—you mean I get to keep my money in a tax-sheltered account and I can get at it before I qualify for AARP?

Rule 72(t) allows you to take money out of an IRA without penalty before age 59 ½ as long as the withdrawals are made in “substantially equal periodic payments” (SEPP). The SEPPs must for at least five years or until you reach age 59 ½, whichever is longer. The rules governing exactly how much you can take out in each payment are fairly complicated, and there are a couple of different ways of calculating it—the IRS can tell you more (You might also try googling “72t calculator,” but I’m not familiar enough with these to recommend one here.)

The few things I've found in print about 72(t) seem to think that the SEPPs are a big drawback. I don't see why they would be. If you're on top of your finances enough to have retired early, you probably have a very clear idea of what you spend and can estimate pretty well how much you want each month and how it could change. With the limited amount of money one can put into an IRA, it’s unlikely that this would be your sole source of cash flow.

Now, clearly, if you don’t have a very solid plan for how you’re going to finance your golden years, taking SEPPs would be really dumb. But if you've got your post-65 life covered through your 401(k), IRA, or other investments and sources of income, and want to retire early, 72(t) allows you to free up some money without paying penalties.