Are you hoping for an early retirement? Even if you don’t plan on retiring early, it still makes sense to consider the possibility. Many people are forced into early retirement because of job loss, disability or other challenges. If this happens to you, a contingency plan could help you better manage the situation.
One of the biggest challenges in early retirement is generating income from your accounts. If you’re like many Americans, you’ve used tax-deferred accounts such as an IRA or a 401(k) to save for retirement. These accounts let you defer taxes on your growth until you take distributions. That tax deferral may help your assets compound faster than they otherwise would.
The catch with tax-deferred accounts is that the funds must be used for retirement. That means you can’t take distributions before age 59½. If you take a withdrawal from a tax-deferred account before that age, you may face a 10 percent early distribution penalty. That can be problematic for early retirees.
The good news is there are strategies you can implement to generate early retirement income without facing the 10 percent penalty. Below are a few ideas to consider:
Take 72(t) distributions.
The IRS understands that there may be situations in which you have no choice but to take distributions from tax-deferred accounts before age 59½. These distributions can be accommodated through a rule called 72(t), also known as the rule of “substantially equal payments.”
Under this rule, you are allowed to take distributions from your qualified accounts before age 59½ without paying the 10 percent penalty. However, you must take the payments every year for the greater of five years or until you reach age 59½.
Also, the withdrawal amount is locked in. There’s no flexibility to change the withdrawal schedule once the payments begin. If you do deviate from the 72(t) schedule, you could face back penalties for all previous distributions.
Withdraw your Roth contributions.
A Roth IRA is a qualified account, but its tax treatment differs slightly from that of a traditional IRA. In a Roth, you don’t receive deductions for upfront contributions, as is the case in a traditional IRA. Instead, your contributions are made with after-tax money.
Since you don’t receive any favorable tax treatment for your contributions, you are always allowed to withdraw those contribution dollars without facing taxes or penalties. That’s true even if you are not yet 59½.
If much of your funds are in a traditional IRA, you may want to consider a Roth conversion. It’s a process in which you move your funds from a traditional IRA to a Roth. You have to pay taxes on the converted amount, but it could be worth it to obtain tax-free income in the future.
Use taxable accounts.
Finally, there’s nothing saying you have to use qualified accounts only to save for retirement. You can avoid the early distribution penalty altogether by saving some portion of your assets in a taxable account. This could be a particularly good idea if you think early retirement is a possibility for you.
Ready to create your early retirement strategy? Let’s talk about it. Contact us today at First Fidelity Group. We can help you analyze your needs and goals, and then develop a plan. Let’s connect soon and start the conversation.
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17000 - 2017/9/25
First Fidelity Group
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