Funding Early Retirement

Most are familiar with the magic ages of 59 ½ when you can start withdrawing from retirement savings without paying the 10% IRS penalty and 62 when you can start taking social security.  But sometimes retirement comes before these ages either voluntarily or involuntarily, and you may need income.  In those situations, many are not aware that you still have options to tap your retirement savings without penalties.

The first option is available if you are at least age 55 and you stop working for your employer.  If your employment terminates during or after the year you turn 55, you are eligible to start drawing funds from that employer’s 401(k) without penalty.  If you have multiple retirement accounts, this exception doesn’t apply to all of them.  It only applies to those employer retirement accounts where you “separate from service” after turning 55.  If you roll the employer plan funds into an IRA, the exception also no longer applies.  For qualified public safety employees who take a distribution from a government defined benefit plan, this exception kicks in at age 50.

Another option is called “substantially equal period payments” or 72(t) distributions.  You can start taking funds from your retirement accounts (401(k), IRA, 403(b), etc.) at any age with this option, although it doesn’t apply to any employer retirement plans when you’re still working for that employer.  To use this option, you are required to begin taking a “substantially equal” amount each year and continue without variation for at least 5 years or until you reach age 59 ½ (whichever comes later).  You have a choice of 3 different calculation methods of your payment.  Once you start, you are committed to using the same method for the duration of the payments, with the exception of one adjustment allowed from two of the methods to the third one.

The IRS is quite picky about the precise calculations of 72(t) distributions and imposes steep penalties for any mistakes.  An error in one year can cause back-penalties on all previous distributions taken.  So you really need to consult a professional to have your distributions calculated.  And once you start, you absolutely have to stick with the program.

With either of these options, it’s important to look at the big picture of your overall retirement funding.  Starting to withdraw from your savings too early can result in a significantly reduced standard of living later on, or it may be just fine in your situation.

Of course, you will still owe taxes on any distributions taken from tax-deferred accounts, and it’s a good idea to plan for those taxes when considering these strategies.

About the author

Jean Keener, CRPC®, CFDP®

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