YOLO. You Only Live Once. If you could retire well before age 65, would you?
Maybe you have a dreadful commute to work or you would rather travel and spend precious time with family.
Have you explored ways to cut your working years?
Not all of us are blessed with an early pension option from our employer or walk into a large inheritance.
I prefer to talk about real methods the everyday working class can utilize from good savings habits to professional advice.
My goal of this article is to share with you a few financial planning strategies people can use to speed up to the retirement chapter of their lives. For those seriously considering retirement in their 50’s or early 60’s before Social Security benefit eligibility, this article is best for you.
- Age 55 Rule
- IRA Rule 72(t)
- Brokerage Withdrawals
- Age 55 rule
Many people hear about the golden age of 59 ½ years old. It is at this age someone is allowed to tap from their 401k, 403b, IRA or TSP without an early withdrawal penalty.
What many workers and even some financial advisors are unaware of is the fact that if you separate from your employer at the age of 55 or later, you are eligible to start taking penalty-free withdrawals from your employer retirement plan.
With proper advice, this age 55 rule can be a crucial 4 ½ years before the standard 59 ½ rule that an early retiree can use to access their money. Surprisingly, there are untrained advisors that may recommend you transfer your old 401k to an IRA without asking you about your early retirement goals.
Do not trust your retirement to an amateur advisor. You can read more on this topic in a separate article I wrote titled “4 Must-Do’s Before Hiring a Financial Advisor” on my blog at www.djavier.com.
An IRA (Individual Retirement Account) has the 59 ½ age requirement similar to a 401k. Once funds move from a 401k into an IRA, you lose the option to exercise this rule.
A key factor for the age 55 rule to work properly is you must separate from service at least one day AFTER you turn 55 years old. Simply put, it is not the age you request a withdrawal that matters but the year you leave your employer.
Example – Tom left his job at age 52 but requested a withdrawal from his 401k at 56 years old. A 10% early withdrawal penalty would be applied. To qualify, Tom would have to retire at 55 years old and then withdraw from his 401k.
Keep in mind, qualified withdrawals from your 401k at age 55 through the use of this exception may still be taxed as ordinary income.
Proper retirement income planning is recommended in order to quantify the necessary amount one needs to withdraw from their 401k. In addition, consult with your professional tax advisor.
For those that work for a Government or state agency and have a 457b plan, there is no early withdrawal penalty to begin with. However, you will be forced to take RMDs (required minimum distributions) upon turning 70 ½.
- IRA Rule 72(t)
For those without an employer retirement plan, what
options do you have? Maybe you are self-employed and have a SEP, SIMPLE or traditional IRA.
Thankfully, the IRS also gave you an early withdrawal option to take these funds before age 59 ½.
Rule 72(t) is a special code issued by the Internal Revenue Service as one of the exceptions to the 10% early withdrawal penalty.
This rule permits penalty-free withdrawals from IRAs provided the IRA owner takes substantially equal periodic payments from the IRA for the later of five years or until 59 ½ years old.
In simpler terms, this means you can you withdraw the same amount from your IRA each year as long as you take the withdrawal five years in a row or until you reach 59 ½ years old, the later of the two.
The amount that you are allowed to withdraw is based on one of three IRS life expectancy tables.
Like the age 55 rule with employer 401k plans, this strategy may be used by an early retiree to fund their retirement lifestyle before they turn 59 ½ years old.
Keep in mind IRA withdrawals are subject to ordinary income tax in the year accessed. Again, make sure to consult with your tax advisor.
Once the rule 72(t) is elected you are not allowed to change the terms. Otherwise, early penalties may apply.
When this 72(t) distribution is put into action, it needs to be done correctly. I believe utilizing this strategy properly is not a do it yourself project. Consult with your Certified Financial Planner to run projections on this type of early withdrawal distribution for your specific situation.
- Brokerage Withdrawals
By now you understand that both employer 401k’s and IRAs have their 59 ½ age restrictions for withdrawals. Interestingly enough, those that save into taxable accounts have more flexibility for early retirement planning.
First, a brokerage account is defined as a non-retirement account that does not offer a tax deductible contribution such as in a 401k or IRA. Money deposited into a brokerage account are technically ‘after-tax’ funds.
Depending on how you invest within a brokerage account you may be taxed on any accrued dividends, interest or capital gains.
A key benefit of using this type of account for early retirement lies in the fact there are no early withdrawal penalties to access your funds.
Keep in mind there will be trading costs to buy or sell individual stocks, mutual funds or ETFs. In addition, capital gains taxes apply if you sell a fund or stock at a profit.
Nonetheless, account owners have full access to their funds to help fund their retirement lifestyle before they turn 59 ½ years old.
This type of account can serve as a flexible spending account in retirement since there are no required minimum distributions (RMDs) a retiree is forced into such as with qualified retirement accounts.
The key to success is how an investor builds their portfolio inside this type of account.
Typically, an investor will want to avoid investing in REITs, commodities and mutual funds with high turnover. All the above have adverse tax implications and can make you pay more in taxable gains.
Some passive index funds can be very tax efficient to invest into since there is no fund manager creating taxable events within the fund. Low cost ETFs (exchange traded funds) can be a great way to avoid high turnover funds and minimize your tax bill.
It is often a great idea for people to open a brokerage account in order to have this flexible type of savings account. For investors that already max contribute into their 401k’s or IRA’s, a side brokerage account can be a great way to accumulate wealth for your early retirement goals.
In conclusion, for those that have strong savings habits and prefer to retire earlier than usual, you have options. These three strategies, if used properly can help you transition to part-time or even no work so you can enjoy the finer things in life.
Consult with a Certified Financial Planner and CPA. As an independent CFP that is legally obligated to act as a fiduciary for your best interests, I can give you that much needed second opinion via a no-cost review. Contact me below.
The above article is informational in nature only. Individuals should always consult with their tax advisor regarding their personal tax situation.
Dustin Javier, CFP® AWMA®
CERTIFIED FINANCIAL PLANNER™
President | Dean Johnson Advisory, LLC
Securities and investment advisory services offered through Ausdal Financial Partners, Inc. Member FINRA/SIPC. 5187 Utica Ridge Rd., Davenport, IA 52807. (563) 326 2064. www.ausdal.com Dean Johnson Advisory and Ausdal Financial Partners are independently owned and operated.