Retiring Early? Here Are A Few Things You Should Know

By Roy Larsen
Posted Tuesday, July 6, 2004

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Due in part to more frequent career changes, economic factors, and layoffs workers today may be faced with different retirement plan options. Regardless of your circumstances, if you’re planning on retiring before you reach age 59½ you will need to make some important decisions.

If you’re like most pre-59½ retirees, you will need to begin taking payments from your retirement savings, such as a 401(k) or IRA, when you stop working. Remember, if you begin to withdraw a portion of your retirement savings prior to reaching age 59½, you may have to pay a 10 percent early withdrawal IRS penalty. Also, if you take payments directly from your employer-sponsored plan, such as a 401(k), your employer is required by law to withhold 20 percent of the amount you withdraw for federal income taxes.

While penalties and taxes may take a bite out of your savings, there is an exception to the 10 percent penalty rule. The “55 and Over” exception is especially helpful if you are nearing the age of 59½ and need a limited amount of money for expenses until that time. Following is an example of how this exception works.

Let’s assume you are 58 years old and your retirement plan balance is $100,000. You will have unrestricted access to your funds in another year and a half, but you need $10,000 to live off of between now and then. Using the “55 and over” exception, you can avoid the 10 percent early withdrawal IRS penalty by rolling $90,000 from your employer sponsored plan into a traditional IRA and keep the remaining $10,000 penalty free for living expenses. Keep in mind your employer will still have to withhold 20 percent of the funds for income taxes.

Another way to avoid the 10 percent early withdrawal IRS penalty, especially if you are under age 55, is by taking a series of equal periodic payments from your retirement plan or IRA – often referred to as 72(t) distributions. Using this method, you are required to take substantially equal payments once a year based on IRS life expectancy tables. To avoid the penalty, the payments must continue for five years or until you reach age 59½, whichever is longer.

Many retirees who have rolled their retirement plans over into IRAs often use 72(t) distributions to gain more flexibility and control over their retirement account investments and receive a predictable stream of income. Although you can begin 72(t) distributions at any age, individuals younger than age 50 must make longer time commitments, which can sometimes create a need to alter the amount of payments, as you will have to spread your retirement funds over more years.

If you don’t need money right away to meet your expenses, it’s not mandatory for you to take distributions from your retirement accounts until you reach the age of 70½. So if this is the case, you may want to consider continuing to defer paying taxes on the money by rolling all or part of it into an IRA. Other options that may allow you to defer paying taxes include moving your funds to another qualified retirement plan, or simply leaving the funds in your employer’s retirement plan a bit longer.

Various options exist for early retirees, and it is important to know what penalties may apply and ways you can avoid them, if you decide to begin withdrawing retirement funds. Talk with your financial consultant about what opportunities are available so you can live a comfortable life in retirement.

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