5 Ways to Tap Your Retirement Funds Before 59½ (Without Getting Burned)

How to Strategize Early Retirement Withdrawals and Avoid Penalties

In this episode of The Retire Early Retire Now podcast, host Hunter Kelly, a certified financial planner, discusses strategies to access retirement accounts before age 60 without incurring a 10% early withdrawal penalty. Key topics include the 72(t) rule, the Rule of 55, leveraging HSAs, Roth IRA contributions, and taxable brokerage accounts. Learn which options are the most and least flexible and how to plan tax-efficient withdrawals. Hunter also covers the importance of proper planning and working with a financial advisor to avoid costly mistakes.

00:00 Welcome to The Retire Early Retire Now Podcast
00:12 Introduction to Early Retirement Withdrawals
01:37 Avoiding the 10% Early Withdrawal Penalty
03:25 Five Strategies for Early Retirement Withdrawals
03:50 Strategy 1: 72(t) Distributions
11:00 Strategy 2: Rule of 55
13:30 Strategy 3: Utilizing HSA Accounts
16:39 Strategy 4: Roth IRA Contributions
18:45 Strategy 5: Taxable Brokerage Accounts
20:45 Conclusion and Financial Planning Services
22:09 Disclaimer and Final Notes

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Transcript

0:00

And welcome back to The Retire Early Retire Now podcast. This is the podcast where we dive deep into all strategies that help high income earners achieve financial freedom sooner, live better, and take control of their retirement. I'm your host, hunter Kelly. Certified financial planner, and today we're talking about all things early retirement withdrawals. So if you're planning to retire before age 60, you need a strategy to access your retirement accounts without losing 10% to early withdrawal penalties today. We'll walk through exactly just that on how to do it. Legally and efficiently. We'll learn about distribution strategies from your 4 0 1 Ks IRAs through something called the 72 T rule Rule of 55. We'll look into HSAs, Roth IRAs and brokerage accounts, talk about which ones are the most flexible, which ones are the least flexible, and give you an idea on how to take those distributions without incurring penalties. So before we jump in, go ahead and like this podcast. So follow it on your favorite podcasting app, share it with a friend, and leave a five star review. Again, those five star reviews are helping out tremendously. Podcast is continuing to grow. So I just want to thank you'cause I want to get this information out to as many people as possible so that they can reap the benefits of an early retirement. Just like you guys that are listening currently. So if you're driving to work, having a cup of coffee. listening to this during a run, whatever that may be. I thank you so much and hopefully you enjoy this content. So why does this distribution strategy matter for an early retirement if you have an IRAA 401k? Other retirement accounts, you could be subject to a 10% early withdrawal penalty. And so there are ways around this. We just want to make sure that we have a plan to avoid this, so that we don't have to give the IRS or Uncle Sam an extra 10% tip when if we just have proper planning, that doesn't need to happen. So. today's episode is going to be geared around how do we start planning for that gap of. Before 59 and a half, transitioning to after 59 and a half. So high income professionals often have their funds locked up in retirement accounts. They do a good job of deferring maybe the max into their 4 0 1 Ks. IRAs, things of that nature. and so oftentimes one thing that is forgotten is, well, how do we start to plan to take these off so that I can supplement my income because maybe I'm gonna go do that, charity work or volunteer work, or work in a different profession that I don't work or I don't make as much as I used to. So I do need some something to supplement my income, or I'm gonna retire completely. Because I have other hobbies that just don't produce income at all, whatever that may be. There needs to be a plan to be able to access these accounts without paying Uncle Sam an extra 10%, because that can make a drastic difference in your net worth over time versus taking those distributions out. and not paying that penalty and reducing tax where we can, right? And so what we'll do is we'll start out and we're gonna talk about five different strategies. One, we're gonna talk about which ones are the least flexible, which ones are the most flexible, and give you some ideas on how to implement some of these strategies. And then moving forward into next week's podcast, we'll talk about how to mix these together and, do it from a tax efficiency standpoint, not just avoiding, The 10% penalty rule and things of that nature. So the first one, and what I would consider the least flexible strategy would be your 72 T distributions. This is one that is also not highly publicized, as some of the other rules and, and distribution strategies, is one that is often forgotten. but there is a way to. Use your IRAs, use your 4 0 1 Ks and other employer plans to, take, distributions without receiving that 10% penalty. And so here's the 32nd synopsis. What is it? the rule is substantially equal periodic payments over time. There's generally, a timeline commitment. So the pros are you're able to access your IRAs and 4 0 1 ks without penalty. the cons, you're kind of locked into this distribution, which we'll get into in just second, which is inflexible. So once you decide the method of how you're taking this distribution, you need to do it for at least five years. Or until 59 and a half, whatever comes last. So you could be locked into these distributions. Let's say if you retire at 50, you could be locked into these distributions for nine years. like I said, it is a way to avoid the 10%, but it's going to give you the least amount of flexibility. with these distributions. So let's say you're already fairly close to an early retirement, or let's say you thought you could retire early, and one thing that was holding you back is the vast majority of my funds are locked into my employer plan or an IRA and I just don't wanna pay that 10% penalty. Well, 72 t distribution. Option or strategy is going to be, something that you can utilize to avoid this 10% penalty. And so how do we do that? One, we need to determine what accounts are eligible. qualified retirement accounts are the ones that are gonna be eligible. traditional IRAs. 401k from previous employers. it cannot be your current employer unless you have separated from service. So separated, could be fired, quit, retire, whatever that may be. and so you have to just be, have an account that's eligible. And so as long as you have an IRA or some sort of employer plan where you have broken service, then you can use that account. the next thing and the most substantial thing is that you'll have to have substantial, substantially equal payments for longer than five years or until you're 59 and a half, whatever comes less. And so how do we one, choose, or, come up with a calculation that is substantial, and equal and we'll talk about here in a second. So these are some questions that you have to answer yourself. What interest rate am I using to calculate this and what does that mean? and then how do I stick to the rules and report this to the IRS and and so on and so forth? So, uh, first we wanna choose our calculation methods. So there's really three methods that you can choose. one would be a method, require minimum distribution method where you can divide your account balance. Buy your life expectancy factor from IRS tables and then calculate your annual, distribution amount, which generally gives you the lowest payment over time. So if you don't need necessarily a ton of money, or you want to try to get as leased out of that account as possible, using this method may be your best bet. There's an amortization method where you take fixed payments based on amortization. of the balance over your life expectancy using reasonable interest rates. And then the last one would be annuation method. Also fixed, but uses annuity factors calculations again via some, IRS tables. we won't get deep into these calculation methods. Just want to go over them quickly on how you would do this. Obviously this is a very complicated. calculation, for most people, it's not something that, again, is easy to do. do your research, work with a financial advisor, to help you implement this if this is something that you're considering. the next thing, what is a reasonable interest rate? for amortization, the interest rate must be the lesser of 5% or 120% of the federal midterm rate, published by the IRS. So again. A lot of these, standards are set by the IRS no surprise, because they're the ones that are implementing this rule, right? and then once you calculate your annual payment, you'll want to take that withdrawal each year. You can break it down monthly, quarterly. et cetera, whatever fits your needs. And then you would need to continue these payments for at least five years or until 59 and a half, whichever is longer. So again, this is not gonna give you a lot of flexibility. So if you need,$30,000 a year and you come up with your calculation, you're gonna need to do that for at least five years, if not longer, depending on when you retire and when you turn 59 and a half. You cannot take extra withdrawals or modify your payment amount unless you're making a one-time switch to maybe the RMD calculation versus the amortization or an ization. and so breaking. these rules or this, distribution schedule can result in a retroactive 10% penalty and interest on all past withdrawals. So again, this is why it's important to work with a professional, do your research and make sure that you're doing this correct because the last thing you want is to take, seven years worth of distributions, do something incorrectly, and then have 10% penalty, plus interest on all of these. distributions that you've taken over the years. And then lastly, and most obviously, you want to report these distributions, file form 53 29 on your tax return to indicate the distribution was taken under. The section 72 T to avoid penalty, and then use code two, on your 10 99, which your custodian would likely help with all of this. you just wanna make sure that these are done correctly, but I. Really just what I'm getting at here is report a proper tax forms so that the IRS is not charging you that 10% penalty. So let's just do a quick example. Let's say you're 50, you have$600,000 in a traditional IRA using the amortization method, life expectancy of 35 years at a 5% rate. Your annual distribution might be around$34,000 a year. you would need to again, take that distribution until 59 and a half, and you would not really be able to deviate much from that. So just keep that in mind. This is a good option, but is also the least flexible option. And so I know that was a little bit long. I wanted to spend a little bit of time on that because most people have not heard of that. but it is an option. So if you're getting close to retirement, you didn't think you would ever have the ability to retire early and all of your, most of your money's locked up in, in IRAs and old employer plans and things of that nature, 72 T might be a good option for you. So number two. also one that's not talked about a lot, but gives you a little bit more flexibility is called a rule of 55. So what is a rule of 55? It allows for penalty free withdrawals from your 4 0 1 Ks and 4 0 3 Bs. If you leave your job when you turn 55 or later. So if you're 55, 56, 57, 58 and you leave and you leave the money in that employer plan, you can always take distributions and avoid that early withdrawal penalty. So this only imply applies to current employers though. So this is where the, a little bit of the flexibility is lost. So if you have IRAs or you have a old employer plan, the distributions would only be allowed from. The current plan that you retire from. So let's say you worked for GE from age 25 to 45. You had a large portion of a, of your net worth in this ge GE 401k. You switched over to another company for the next 10 years, and you retire at 55. Well, then you would only be able to use that new employer plan for the rule of 55 if the GE was either in a IRA or still in the GE plan. So you would want to make sure that you plan for that. You could always move some of that money into the new 401k. and that would be allowed, to. To be, distributed to avoid the penalty as long as it was in that new employer plan when you retired after on or after 55. So this one gives you a little bit more flexibility in the sense that you can take as much or as little as you want and avoid, the 10% penalty. But the where you lose that flexibility is it has to be in that employer plan. So if you wanna roll that money over to an IRA, because. Maybe there's not very good investment, portfolios in there, or mutual funds, ETFs, whatever's in that 401k, then, you're gonna want to strategically think about, okay, well how much do I need to leave in there so that I can take enough distributions, to, to meet my, to meet my needs until I'm 59 and a half? So think about that. and so that'll give you a little bit more flexibility, but there are some nuances there Again. If you're working with a financial advisor, they should be well versed in this rule to help you take the proper distributions, given your situation. Number three is a little bit off the wall thinking outside the box. and I like it for a number of reasons.'cause healthcare is not, is one thing that, generally keeps people from retiring. And so if you plan this right, if you're in your thirties. or early forties, you can start to plan this and really use this to the full potential. But that is your HSA accounts for retirement to either help supplement to, pay for healthcare costs, or, use some of the withdrawals for retirement, tax free. So, again, HSA is generally associated or is associated with high deductible plans. if you're, if you have a family, you can put up to about$8,500 a year into that account. That will be tax deductible. It will, if you invest that money, it will be tax free and then it will be tax free on those distributions for qualified medical expenses. But this is where it gets good. You can always pay for your health expenses out of pocket. Keep record of those expenses, continue to let this money grow, and you can always take that tax free distribution out later. So if you're in your thirties, if you're in your early forties, mid forties, whatever that case may be. And you have a few grand worth of medical expenses a year, and you pay for that out of pocket, you can start to rack up those, expenses, accumulate those expenses, and and then use those later on. So let's say you decide to retire at 55 and you've racked up$60,000 worth of medical expenses. Well, that can be,$60,000 that you could use toward. paying for private health insurance because you've technically already, quote unquote, spent that money. You can take that qualified distribution and it be tax free. And then all that other money that had been growing through investments, then you can use that for your new, deductible out-of-pocket max co-insurance, things of that nature. So that, that is one strategy that I'm using. Right. I'm in my mid thirties. we're contributing to an HSA and so hopefully whenever I decide to retire, I'll have a large sum of money in that particular account. some of that will be able to be used. At will because I'll be able to reimburse myself for those previous, years of medical expenses. but then also I'll have hopefully 15, 20 years worth of growth on that money that I can use for medical expenses moving forward as well. and then for whatever reason, if there's still money left in there when you turn 65, you can always take those out, and just pay that income tax just like you would like an IRA. Or 401k. HSA is a great way to kind of plan for health insurance and medical expenses, along the way. Especially if you can pay for some of those expenses out of pocket early on, keep that money invested and then reimburse yourself, later on down the road. Number four is Roth contribution. So just like number three, number four is going to require, some record keeping. because one of the things that does get, some publicity and. a lot of advisors, the ones that are on YouTube and things of that nature do talk about a lot, is that you can take your contributions out tax free at any point without penalty. So if you've been contributing to your Roth IRA, since you were 25 and now you're 55, that's 30 years worth of contributions that you can take out penalty free. Now, generally speaking, strategy purposes. We wanna leave as much as we can in the Roth because it's, it's gonna give us the most, most tax, efficient growth and distributions and things of that nature. But if you're, if you design your plan where, Hey, I'm going to use some of these contributions, to supplement my early retirement for a year or two or five years, whatever that may be, then you're gonna want to keep a record. Of your contributions through what's called a 54 98. I know it seems cumbersome sometimes, but. With your custodian, whether you're using Fidelity, Vanguard, whatever custodian that your advisor may be using, whatever you wanna make sure that you get that 54 98 and file it with your taxes every year so that, you have record of, Hey, I've put in a hundred grand, into the Roth IRA over a number of years. I can use this, for, distributions early on in that receive. any sort of penalty or tax on these withdrawals. And so money, you move from a traditional IRA to a Roth and you wait five years, I. you can withdraw without penalty as well. So that would be like a, like a contribution. So if you can do a large conversion, let's say when you're 50 and then you're 56, so you convert it, a hundred thousand dollars when you're 50, well, all of that would be considered a contribution. because you've already paid taxes on it, so you could actually use that. as a withdrawal as well without penalty. So just keep that in mind. Number five, taxable brokerage accounts. I talked about this a lot. This is gonna give you the most flexibility. so if, again, if you're in your thirties, early forties, or maybe you're still three, four years out from retirement, taxable brokerage account is gonna give you the most, bang for your buck, the most flexibility. And you're gonna have obviously no withdrawal penalties, because it's not. titled into a retirement account or anything like that so you can manage your capital gains through tax loss, harvesting, bracket management, whatever the case may be. And then if you play your cards right with the type of income that you're pulling from, you may also be able to avoid capital gains, given that the bracket from, zero to about 90,000 if you're marrying, filing jointly, and then zero to, let's say about$50,000. allows you to have a 0% capital gains rate. obviously you would want to seek tax advice on those types of strategies, things of that nature. But the brokerage account is gonna give you the most flexibility in terms of taking distributions before 59 and a half, but the tax situation is not as favorable as you, invest and contribute along the way. But there are some things that you can do to mitigate those taxes, along the way, and then through withdrawals as well. the brokerage account is gonna give you the most flexibility. That's why I generally advise people that want to retire early to at least segment some of those contributions, to a more long term play where they don't consider it for any, short term or, medium term. purchases like cars and houses, vacations and other expenses of that nature, but it is purely, segmented for retirement. they don't even consider taking it, but if it's there, if they need it for emergencies, things of that nature, they certainly could touch it. And then obviously for, an early retirement as well. Those are the five options to take withdrawals early to, avoid that 10%, 10% penalty withdrawal. so obviously there's a lot more strategy that goes into, how do, which one do I take from first? How do I take from it? how do taxes come into play? How much should I be taking? as a total from these accounts, based off what I need to live and things of that nature. that's where I think that if you're confused, maybe you don't have the time, the capacity, or the expertise to come up with a plan, reach out to a financial advisor. That is what I do at Palm Valley Wealth Management is I create these strategies to help people retire early from starting out to transitioning into retirement. so if you would like help if you're unsure about your situation, go to my website, Palm Valley wm.com. I. I would love to schedule a call with you. It'll be a no cost call. We can get into all the questions that you have, understand how I work with clients, understand if we're a good fit, things of that nature. And if it's something that you wanna move forward, we can certainly help you create a plan to retire early, transition into retirement, things of that nature. So we'd love to have that opportunity. And if you've liked this podcast, please share it with a friend and leave a five star review on your favorite podcasting app, and we will. We will see you in the next one. This podcast is for educational purposes only. It is not meant to be investment or financial planning advice. Do not make decisions solely based on this podcast alone. Please seek professional help on your own situation before making decisions. Please keep Palm Valley wealth management in mind when making those considerations.