How do I avoid the 10% early penalty?

Qualify for an exception — disability, medical expenses over the threshold, first home ($10,000 lifetime from IRAs), higher-education costs, SEPP payments, or separation at 55-plus from the plan sponsor. Document the exception on Form 5329.

What is a 72(t) SEPP plan?

Substantially equal periodic payments computed by an IRS-approved method, taken at least annually for five years or until 59½, whichever is longer. Break the schedule and the 10% applies retroactively with interest — precision instrument, not a suggestion.

Are annuity payments fully taxable?

Only the earnings slice: the exclusion ratio returns your after-tax basis pro-rata with each payment until recovered. Employer-funded and pre-tax annuities are fully taxable — no basis, no exclusion.

IRC §72 · 26 U.S.C. §72

IRC §72: Annuities and the Early-Distribution Tax

By Paul D. Diaz, EA, MBA · Updated September 20, 2026

IRC §72 taxes annuity payments through the exclusion ratio — and houses the 10% early-distribution tax that guards every retirement account before 59½. Two statutes’ worth of law in one number.

What it governs

Exclusion ratio: each annuity payment splits pro-rata between basis and income
10% additional tax on early distributions, with a dozen-plus exceptions
72(t) SEPP: substantially equal periodic payments that waive the 10% at any age
Roth ordering rules: contributions first, conversions second, earnings last

In the GuideFull treatment in Chapter 16 of the Guide (principal treatment) and Chapter 14 — THE TAX CUTTERY® Guide to Federal Income Taxation, Professional Edition (564 pages, 24 chapters).

From the practiceStart the consultation — Paul on video, one question at a time →

Questions this section answers

How do I avoid the 10% early penalty?: Qualify for an exception — disability, medical expenses over the threshold, first home ($10,000 lifetime from IRAs), higher-education costs, SEPP payments, or separation at 55-plus from the plan sponsor. Document the exception on Form 5329.
What is a 72(t) SEPP plan?: Substantially equal periodic payments computed by an IRS-approved method, taken at least annually for five years or until 59½, whichever is longer. Break the schedule and the 10% applies retroactively with interest — precision instrument, not a suggestion.
Are annuity payments fully taxable?: Only the earnings slice: the exclusion ratio returns your after-tax basis pro-rata with each payment until recovered. Employer-funded and pre-tax annuities are fully taxable — no basis, no exclusion.

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