How To Access Your Retirement Accounts If You Want To Retire Before 59 1/2

 

 

Troy Sharpe: What do you do if you want to retire before 59 and a half? If all of your money is inside that tax infested retirement account, you could be subject to a 10% early withdrawal penalty on top of income taxes being owed, federal and possibly state, depending on where you live. I want you to be prepared by understanding what your choices are, how to build options for yourself leading up to retirement, if you’re retiring before 59 and a half. I’m going to cover seven different choices that you have to avoid that 10% penalty, if you want to retire before 59 and a half.
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Hi, I’m Troy Sharpe, CEO of Oak Harvest Financial Group, certified financial planner professional, and host of The Retirement Income Show. When we talk about retiring before 59 and a half, many of you don’t want to hear any of it, you don’t know what you do with your time, and others can’t wait to get out of work and you’d like to retire as soon as possible, but the cost of health insurance premiums, the inability to access your money, these are all big hurdles that keep many people in the workforce for a long time.

Everyone’s situation is different. You need a financial plan, you need to be connected to how much your savings can provide you an income with respect to taxes, inflation, healthcare expenses, all of the needs, all of the concerns that a retirement plan helps to address, but we’re going to go through and help you understand today what some of your choices are. Hey, take one second to hit that subscribe button, hit that bell icon so we can keep delivering powerful content to you, and you can be more educated, more empowered, understand more about retirement. While you’re watching this video, take the time to comment down below, let me know what you think.

I’m going to start with the most simple one first. If you’ve heard me say this one time, you’ve heard me say it a thousand times, you should be saving money outside of your 401(k).

I don’t care if you want to retire prior to 59 and a half or after 59 and a half. I hate when a client comes in or a prospective client, and all them is inside these tax-infested retirement accounts. If they want to give money to the kids, go on a vacation, buy a second home, anything they want to do, they are subject to paying the government whatever the government says the tax rate is at that time. Once you hit 72 and you’re forced to start taking money out of that account, now you’re potentially in these higher income tax brackets for life, depending on how much you inside your 401(k).

If you’ve heard me say it once, you’ve heard me say it a bunch, please consider saving money outside of your 401(k). I’m not saying forget about the 401(k), but in addition to, we want to get that company match, that’s free money. Let’s diversify our tax buckets, because if taxes do go up in the future, I want you to have places where you can go and take income from. Number one thing to understand is that you get to control what goes on your tax return in retirement. Having some non-IRA money and some IRA money, let’s say we want to take 40,000 from here and 20,000 from here. Only that 40,000 goes on the tax return.

We can have choices. We can essentially manipulate our tax return in a good fashion. I’m not saying break the law, but I’m saying where we take our income from and how much we take determines what goes on that 1040, which then determines many other aspects of the tax code, not just how much income tax we pay. Number one, have money in what we call a non-qualified investment account, savings account, whatever assets they are, but don’t have all of your money inside that 401(k).

Number two is the age 55 rule. The age 55 rule says, if you sever from service, you’re laid off, you retire, post age 55, age 55 or later, you can access money inside your 401(k) without a 10% penalty. The catch is you have to leave that 401(k) at your employer. You can’t roll that into an IRA whenever you retire. If you’re you’re 55, 56, 57, you say, “You know what? I’m done,” or you get laid off and you need income because you don’t have assets elsewhere, you should consider leaving that 401(k) at that employer, so you can take income out as needed without paying that 10% penalty. You’ll still have to pay income taxes on those distributions, but you’ll avoid the penalty.

Number three, Roth contributions or Roth conversions. Two different things here. Roth contributions is when you take money from your paycheck and you put it into your Roth IRA. These are after-tax dollars going in, meaning you’ve paid tax on those, and you’re subject to annual contribution limits, either 6,000 or 7,000, depending on your age. If you’re over 50, you get a catch-up contribution of an additional thousand dollars there.

Because you’ve paid tax on that contribution, you do not have to wait until 59 and a half to take it out if you need it. The interest that that money has earned, you do have to wait until 59 and a half, but if you contributed money to that Roth IRA, you don’t have to wait five years. You do have to wait until you’re 59 and a half. You can always access the money that you’ve put into that Roth IRA.

You cannot touch the interest, but whenever you make a withdrawal, they are considered FIFO withdrawals, which means first in, first out. The first moneys you put in, those are the ones that come out first. You can avoid that 10% penalty, have somewhere to take income from if you’ve made Roth IRA contributions leading up to that point where you want to retire without incurring that 10% penalty or taxes or violating the five-year rule for that matter.

For Roth conversions it’s similar, but it’s a little bit different. If you have an IRA and you convert it to a Roth IRA that starts the five-year window. You do have to wait five years before you can take that principle out prior to 59 and a half and avoid that 10% penalty. You still have to wait until you’re 59 and a half or five years whichever’s longer to access the interest penalty-free, but to get your conversion amount, let’s say you put in $100, you convert $100, five years later, you can take out that $100 and avoid that 10% penalty.

One caveat to this, and this also applies to the Roth IRA contribution, if I convert in December or if I open my IRA and contribute in December, the clock actually starts January 1st of that year. If you wait until December to do this, then you actually have just a little bit more than four years to wait. If you open up an IRA, do a conversion, you can access that principle if you wait five years, depending on when you converted there, and you can get that money without a 10% penalty. One thing to also know is that each conversion you do, if you do multiple conversions leading up to retirement, each conversion starts its new five-year window.

The next one, number four, is your life insurance cash values. For most of you out there, if you’re working, you have a family, term insurance is probably the right way to go. It’s very low-cost, it can provide lots of coverage, and that’s what you need it for. When you’re younger, you’re working, you just need death benefit protection, and term insurance is the way to go. For many of you that are may making significant money and you have excess cash to invest or to save, if you’re a conservative-type investor or you also want the death benefit protection or disability protection that life insurance can provide, then this could be a strategy for you.

You have two different types. You have whole life insurance and universal life insurance as far as cash value is concerned. Those are the two primary types. Whole insurance, realistically, you can expect to earn 3% to 4%. It comes from the insurance company, they share their profits with you, they paid in a dividend, but after expenses, 3% to 4% is a reasonable expectation for your whole life insurance. If the policy is structured properly, it grows tax-free as well. Technically it grows tax-deferred, but you can take it out via a loan tax-free.

Indexed, universal life insurance is another way that you can consider going. Less expenses, you can expect to earn a little bit more over time if the markets perform well, but same basic principle, you put your money in, think of it as a savings tool with death benefit protection, it’ll grow if the market goes up over time, or it should grow, it has the potential to grow. When you take that money out, you’re essentially borrowing from yourself.

Too many other aspects of these life insurance policies to get into in this video. Just understand, if you have a lot of income and you’ve maxed out your 401(k), you’ve maxed out your Roth, and you want somewhere else to save, life insurance can be a very valuable tool if structured properly as part of a more comprehensive retirement plan. Those dollars you can take out tax-free to help bridge that gap between whenever you retire and 59 and a half.

Number five, in this super low interest rate environment, consider a cash-out refi of your home. If you have equity inside your home and you’re retiring, I know many people will tell you, you don’t want to do that because you don’t want to go in debt. Maybe that is absolutely the case for you, this is where financial planning comes in. If you have have a choice, let’s say your home is worth $500,000 and it’s paid off or darn near paid off, and you have two years to go before you can access your money, would you rather do a cash-out refi and maybe your interest rate is 3% or 4% or go into your IRA, take money out, pay a 10% penalty plus whatever income taxes that are due?

I’m not telling you to go do this, I’m saying it is an option. Please be aware of it. Comparatively speaking, if we’re just looking at the numbers, the interest rate that you’ll pay on that cash-out refi most likely will be a lot less than the 10% penalty and whatever income taxes you may owe on that distribution from the retirement account.

Number six, 72(t) distributions. This may be something completely new to a lot of you. 72(t) distributions essentially give you the opportunity to take a series of substantially equal periodic payments as a distribution from your retirement account. You have to do this for a minimum of five years or until your 59 and a half, and it’s whichever is longer. If you’re 57, you have to do it for five years. If you’re 50, you have to take a series of substantially equal periodic payments until you’re 59 and a half. To see what you qualify for, you have to understand a couple of components.

One is the federal midterm rate. Right here, federal midterm rate it changes December 2021, it’s 1.26. With a 72(t) distribution, you can take out a maximum of 120%, or excuse me, the interest rate that you use to calculate can be a maximum of 120% of the federal midterm rate. This is a Bankrate calculator. You can go to bankrate.com, type in 72(t) distribution or just do a Google search, there are actually three different methods.

Just to give you an idea here, I have a $1 million account balance. 120% of that federal midterm rate is 1.51. If you’re 50 years old, your maximum 72(t) distribution is 37,652. You would take that, you have to take that for 10 years, because you’re 50 in here, or until 59 and a half. If you mess up that schedule, meaning you take more, you take less, you don’t take it, then that 10% penalty can retroactively be applied to all of those distributions that you’ve previously taken, but the 72(t) is an option to explore if you’re retiring before 59 and a half and all of your money is inside that tax-infested retirement account. Talk to your financial institution, talk to your CPA, but just be aware that this is an option, and then that education empowers you to explore it a bit further on your own.

That’s the basics of the 72(t) distribution. I’m going to do another video, a separate video, to go in a little bit more detail, look at some different examples for 72(t) distributions, also to make it more widely available if someone’s online searching for 72(t) distributions, but understand that that’s a way, use that knowledge to go find out a little bit more for yourself.

Number seven on our list is IRA hardship distributions. I just want to run through them. I’m going to do another video that goes into a bit more detail about some of these and the planning opportunities that surround them, but this is a bankrate.com article. You can do a simple Google search, IRA hardship withdrawals, understand that they are different, the rules are different from your 401(k) hardship withdrawals. We have unreimbursed medical expenses for disability. These are reasons you can go into the IRA, take money out, not pay that 10% penalty. You still have to pay income taxes.

Disability, health insurance premiums, this is a big one. Many people continue to work because the cost of health insurance. Theoretically, this doesn’t reduce the cost of health insurance but please be aware at least you can go in there, take money out to pay your health insurance if you retire prior to 59 and a half and avoid that 10% penalty. Depending on what the cost is or depending what your other income is, you may even be able to keep your modified adjusted gross income to a point to where you can qualify for a subsidy. There’s some planning opportunities there.

Upon death, this is for inherited IRAs, if you inherit an IRA, you do not have to pay that 10% penalty to make any distributions. If you owe the IRS, no one wants to owe the IRS, but if you do, the IRA is a place where you can take it without paying that 10% penalty. First-time homebuyer. To qualify as a first-time homebuyer, you simply cannot have owned a home within the past two years.
Number seven on the list is higher education expenses. This is post-secondary school, it could be for you, it could be for your spouse, your children. You can take money from that IRA, avoid the 10% penalty for tuition, room board, et cetera. Then the last one on those lists we talked about before, it’s for income purposes, 72(t), it’s section 72(t) of the Internal Revenue Code, does allow you to take money out. We covered this already, plus I’m going to do another video on it. I’m actually also going to do another video on all the hardship distributions to go into a little bit more detail.

In summary, we have non-qualified money. Don’t save all of your money inside that 401(k). Get some money outside of there that you can access without these 59 and a half restrictions if you want to retire before 59 and a half.

Number two was the age 55 rule. If you sever from service, meaning you are laid off, you retire, you no longer are working at age 55 or beyond, but younger than 59 and a half, if you leave that 401(k) behind, you can access the money in that account. Still have to pay income taxes, but you will avoid that 10% penalty.

Number three, Roth contributions or Roth conversions. High level, anytime you make a Roth contribution, which is subject to either the 6,000 per year or 7,000 per year limit, this is using your after-tax dollars to contribute to a Roth IRA. You do not have a five-year rule, you do not have to wait until 59 and a half to access the money that you put into that account. Any of the interest, you do have to wait, five years or 59 and a half, whichever is longer.

The Roth conversions. You do have a five-year window if you do a conversion, but once you’ve done that conversion, if you’re 52, 53, 46, once you’ve done that conversion, five years later, you can access that principle amount that you converted without a 10% penalty. To get the interest, you still have to wait until 59 and a half or five years whichever is longer.

Number four was life insurance. If you have whole life insurance, if you have universal life insurance, these are places where you can access money not only penalty-free, but usually tax-free if the policies are structured properly. Again, most of you, term insurance is probably the right way to go when you’re younger and trying to provide death benefit protection, but permanent life policies can be good places to save money conservatively for people who have excess income, but also need that death benefit protection. It’s all about having a comprehensive financial plan.

Number five was 72(t) distributions. We’re going to do another video on this, but if you want to learn more, go back in the video or simply Google it, find it online. You can find a calculator, and this should help you do a little bit more research.

Number six, consider the cash-out refinances opposed to going into your retirement account, paying a 10% penalty plus income taxes to bridge that gap until you’re 59 and a half. Normally, I don’t like to encourage people to take debt, but I do want you to understand that this is an option, view it as a short-term bridge. Once you reach that magical 59 and a half number, I’d make a deal with myself to come up with some type of payment plan to get the money back in there, pay off that cash-out refi, but everyone is different. Your circumstances, your risk tolerance, your willingness to go in debt. Just understand that it’s an option. For some of you, it may be a great option, for some of you, maybe it’s a really bad option, but nonetheless, it’s an option.

The last one we talked about today are the hardship distributions from your IRA. Again, you can Google this, lots of information on the internet. There are several of them that can allow you to avoid that 10% penalty, but they are hardship distributions, meaning something has to have have happened in order for you to take money out of the IRA, to qualify for one of these hardship distributions and avoid the 10% penalty. You’ll still have to pay income taxes, but it’s an option.

As always, thanks for watching the video. Comment down below, subscribe to the channel, and hit that little bell icon, so you can be notified when we upload new content.
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Summary
How To Access Your Retirement Accounts If You Want To Retire Before 59 1/2
Title
How To Access Your Retirement Accounts If You Want To Retire Before 59 1/2
Description

If you want to access your retirement accounts before 59 1/2, you will be subject to a 10% penalty. But, there are ways to access those accounts without the penalty if you want to retire early.