6/20/2013 7:45 PM ET|
Early retirees: How to make withdrawals
There are myriad rules and regulations about early withdrawals from 401k's and IRAs. If you're retiring early, make sure you know the rules.
Many of us invest in tax-advantaged retirement accounts such as a 401k or Roth IRA to save as much as we can. But these accounts can create challenges for people who are forced to leave a job or decide to retire before 59 ½.
The government discourages people from dipping into their retirement funds by levying a 10% penalty on withdrawals if you’re younger than 59 ½. However, retirement doesn’t always go as planned, and many people will need to use these early withdrawal options:
Use other assets first
The easiest option is to use your other assets to bridge the gap until you’re 59 ½. Funds from a taxable brokerage account, bonds, CDs, or other investments can be cashed in to fund your expenses until you can withdraw from your retirement accounts with no penalty. This is why it is important to start making passive income before you retire. A home equity line of credit might be a good option if it’s only a short time before you’re 59 ½.
Other options are to work part time or to generate a small income from self-employment to cover some expenses.
You can take penalty-free withdrawals from a Roth IRA, if they don’t exceed the amount you contributed and the account is at least five years old. But the earnings in the Roth IRA don’t become tax free until you turn 59 ½. And if you take money out, you’ll have reduced its ability to grow. Once you take out the money it can’t be put back in.
Early 401k distribution
If you retire or are fired from your job after you are 55, then you can withdraw from your 401k without having to pay the 10% penalty. But this rule only applies to your current employer’s 401k plan.
If you have a 401k with a previous employer, you still have to pay the 10% penalty if you withdraw from that account before age 59 ½. One simple way to avoid this penalty is to roll over the 401k from your previous employer to your current plan. Also, this exception only applies to your most recent 401k and not IRAs. Some 401k plans do not offer this option, so you will need to verify whether or not you can do this with your plan.
Annuitize your IRA
If your IRA is comfortably large, then 72t distributions might be a good option.
Setting up 72t withdrawals means you’ll take substantially equal periodic payments (SEPP) based on your life expectancy. The withdrawals will have to continue for at least five years or until you reach 59 ½, whichever is longer. If you’re 52, then you’ll have to continue withdrawals until you’re 59 ½. If you’re 58, then you’ll have to keep withdrawing until you’re 63.
The withdrawal math is somewhat complicated, and there are three different ways to calculate your withdrawal amount. You might want to see a tax professional to make sure you do the calculation correctly. If you make a mistake, you’ll be hit with the 10% penalty on the entire amount withdrawn.
Avoid early withdrawals if possible
Generally, it’s a bad idea to take early withdrawals from your retirement accounts. That’s why the IRS discourages it with the 10% penalty.
By withdrawing money early, your retirement portfolio will be much less likely to last for the rest of your life. Investing in both a 401k and Roth IRA is still a great way to save, even if you plan to retire early. However, it’s better to find a way to make things work so you can keep the retirement portfolio for when you’re older than 59 ½.
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First, before retiring early, be darned sure you have a long record of living on what you believe will be your income per year. Several years of living with a paid-off mortgage will go a long way to helping you meet that goal and will also enable greater savings to help bridge those early to generally accepted retirement years - lessening the need to tap a 401k or IRA and allowing it to grow just a little bit more absent withdrawals. Use care to account for/save extra for medical insurance costs as you may forfeit insurance when leaving your current employer.
NEON GUY makes a solid point. How long before the S.O.B's and liberals in DC change the rules to screw us out of money WE earned and tried to save?
They are looking to steal more money from every direction they can. It might be the super wealthy right now but given the opportunity and their zeal to spend and spend tax dollars they will be coming for everyone's money.
How about term limits? How about any law passed includes no loopholes for congress and senators?
How about a balanced budget? How about cutting Govt by 50% and starting over with single issue laws and NO pork attached?
Wow! That was certainly a non-informative story Mr Udo. I think any of us could have done a few minutes research and written something other than can be found on a pamphlet from most investment companies.
Shame on the government.
He hints at it with 72t but he does not disclose the most important aspects of IRS code 72t. Hmmm...
I estimated how much income we could have and stay in the lower bracketts. That is how much I took out for the last several years. Paying ordinary taxes on 401k withdrawals makes you have to plan ahead like that. Stocks you sell outside of your 401k are taxed like capital gains. So any profits made now should cost us a lot less in taxes.
Just because you take a 401k out and pay taxes on it, that doesn't mean you have to spend it. I didn't want the children to have to deal with an inherited 401k. I have heard the taxes are high on those, but I don't know.
We put some in savings (ugh, no interest...) then bought some stocks with the rest of the money. Now, when we need to use some of the money, we don't have to worry with taxes.
Medicare premiums are being based on your yearly income after a certain amount. That is something else to keep an eye on.
We bought the best Medicap and prescription drug plan we could. Medicap is almost like prepaying for your part of the medical expenses, but now the republican leaders want to make everyone have to pay high copays and deductibles. They want Medicap to be like the Prescription plans. There isn't a good Prescription plan in this area. I take two drugs that are in patent and have no competition. They are EXPENSIVE. Medical costs are the reasons we have to spend on our savings.
Anything that the IRS discourages, should be ENCOURAGED.
I cashed out my 401 5 years ago; yes I paid a penalty and taxes, but guess what? that money is doubled and SAFE from the government.
If I had left it alone I would have lost over 60% of MY money.
I wouldn't have a 401(K) again if you paid me.
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Which store penalizes you for too many returns? And which one will let you retroactively apply coupons?