Level 1 – The Basics – Withdrawal Stage

You are on part 8/9 in the Level 1 – The Basics Series. Next up: Your Life in Retirement
1. Why Retire Early?
2. The Basics – Overview
3. Income
4. Saving
5. Spending
6. Debt
7. Investing
8. Withdrawal Stage
9. Your Life In Retirement

On the journey to early retirement, knowing exactly how you plan to access your savings is key. It’s hard to plan for the future, when access to funds is murky. Most people think that early retirement is impossible in part due to the rules governing withdrawals from retirement accounts. For instance, one of the most common questions I hear is “all my savings are in my 401K, and I want to retire at 40. How do I access my money without handing over massive amounts of money in penalty payments???”

Great question. It’s really not that difficult.

Let’s go account by account.

Cash –Use as you see fit. No penalty and no taxes are to be paid when you spend this money.

Taxable Accounts – This includes any personal brokerage accounts in which you own stocks, bonds, or mutual funds. This may also include any company stock you may been granted while working. These accounts are great for early retirement, as you can sell shares and use the funds anytime you wish. You’ll pay capital gains tax on any growth from the previous years, but after that you are on your way.

Roth IRA – A Roth is one of my favorite retirement vehicles. You can pull the contributions out, tax free, at any time. In other words, anything you personally put in, whether it was at age 25 or 50, can be pulled out at any time. The earnings, or growth of that money, is a different story. You really can’t access the earnings, or growth, penalty free unless it’s for a new home, suffered a disability, or is being distributed after you pass away.

Health Savings Account (HSA) – This is the coolest investment account ever made. It wasn’t put in place to serve as the best retirement account there is, but that’s exactly what it turned out to be. You can access both contributions and earnings, all money in your account, at any time both tax free and penalty free. The only caveat is that the withdrawals must be for qualified medical expenses. Not a bad thing if you plan ahead. If you save your receipts over a period of 10 years that totals $15,000, you can then withdraw $15,000 at any time. If you plan ahead, the HSA is the best retirement account you can find.

Defined Benefit Pension Plan – These days, defined benefit retirement pensions are fairly uncommon, but if you have an employer that sponsors one, and you worked long enough to qualify, you are in great shape. With these plans, your employer likely contributed a sum of money to an investment account over your years of service and at a certain age, or after a certain number of years of service, you will receive set payments from these accounts. You’ll pay taxes on these payments, but no penalties. If you are even luckier, your plan might even have a Cost of Living Adjustment (COLA), which helps ensure the payments to you maintain buying power and keeps up with inflation (a really good thing!).

401(k) / 403(b) / 457(b) / Individual Retirement Account (IRA) – At age 59.5, you can access your money penalty free. You can withdraw as you see fit. However, do keep in mind that you will pay income taxes on any money you withdraw, so make sure to be strategic on how much you cash out each year.
At 59.5, you don’t have to withdraw money, instead you have the option. Once you reach age 70.5, you are required to take what is called a Required Minimum Distribution (RMD). Each year thereafter you are required to take a RMD from your account and pay associated taxes on that money. RMD’s are calculated by your life expectancy and amount of money in your account.

Now, the question most want to know, “how can I access this money if I retire early?”

For those wanting to access your IRA before age 59.5, you have several options.

1) Just take the money out as desired and plan to pay the 10% “early withdrawal penalty” and income taxes. This approach really stinks, as you are giving away a chunk of your savings as a penalty. However, this approach is fairly straightforward.

2) 72(t) Substantially Equal Periodic Payments (SEEP) – With this option, you set up a withdrawal from your account that will occur on a go forward basis until your standard retirement age. You won’t have to pay an early withdrawal penalty, which is great, but you will still have to pay taxes. The downside is that once you set the 72t in motion, you can’t stop it (unless you pay even more penalties). A 72t is active for a minimum of 5 years, or until you reach age 59.5, whichever is longer. This isn’t necessarily a bad thing, but it does mean you will likely be withdrawing during times when the market is down, or when you might not even need the money.

3) Roth Conversion Ladder – Take funds and convert them from your traditional IRA to a Roth IRA. You’ll pay taxes on the conversion, but not a penalty. After the first conversion, you’ll now have to wait 5 years. After five years’ time, you can withdraw the conversion, tax and penalty free! To make the conversion ladder work as desired, you’ll likely have to convert funds from the traditional IRA to the Roth IRA on a yearly basis.

Even with the strategies laid out above, I have heard some people say that they don’t plan to fund their tax advantaged accounts because they want to retire early, and don’t want to worry about the penalties. Wrong answer.

Let’s look at the numbers with a Bob example. Let’s say that Bob has $18,500 to invest each year, starts with $100,000 in savings, and expects a market return of 9%. He can either:

A) Fully fund his 401k and defer taxes on the earnings.

B) Pay taxes and invest in a personal brokerage account, and have full access to the money at any time.

After 20 years of investing, what does his account look like?

A) His 401k sits at $1.59 million

B) His personal brokerage account sits at $1.33 million.

Let’s assume he wants to access his 401K and decides to pay the 10% penalty on the full amount in the account, he would pay a penalty of ~$159,000. This leaves him with $1.43 million. So…even after paying penalty, Bob has more money that he would has in the personal brokerage account, pretty neat.  Oh, and this doesn’t even consider any employer match that Bob may have been given!

The choice is clear, even if Bob has to pay a penalty to access his funds, funding his tax deferred account is the right choice. I’ll go into this concept much more in the future, but for now, give the MadFientist a read (https://www.madfientist.com/how-to-access-retirement-funds-early/), he covers the concept in great detail.

Deferred Compensation – Deferred compensation accounts are employer sponsored benefits where they allow an employee the option to contribute up to a certain percentage of their compensation to a tax privileged account. Typically, these accounts are for higher earners. For an early retiree, there is very little way to avoid the tax hit associated with this account. If you pull the plug and retire before the age your company lists as a minimum retirement age, your entire account will immediately be paid out to you, in full, leaving you with a massive tax bill to pay.

There is no way around this. However, if you retire a bit later and qualify as retirement age, you might be able to have your account distributed to you on a partial basis, greatly reducing the tax bill.

Social Security – Full retirement age sits at 67, crazy, I know. At age 67 you receive your SS payments at no reduction. However, you can start pulling in SS payments as early as 62, with a 30% reduction to the expected payments. Each year later that you start the payments, a smaller reduction is incurred. For example, if you started payments at age 66, your reduction is only 6.7% vs. the full payment at age 67 (Link).

If you have noticed, I don’t talk much about social security on this website. I don’t include it in any of my retirement calculations. I am in my 30’s and have more than three decades between myself and any potential SS payments. If I was in my 50’s today, I would absolutely add more SS impact into my retirement calculations. I strongly believe SS will be around when I turn 67, but I have no clue what it will look like, so I plan my path assuming it will have minimal impact to me. If it is still around and when I turn 67, it will just be gravy on top. For those closer to a traditional retirement age, do please read more, and even go estimate your potential benefit payment (Link).

These are just a few of the most common retirement accounts. There are numerous ways to access each account, making the money you have available much sooner than you may expect.

Most people see retirement as 59.5, at the earliest due to the regulations around their “retirement accounts”. Not so.

For those of you reading here and willing to learn a bit more, there is a very clear path on how to access the money you saved, regardless of where it sits today. Much more detail on each of these accounts and how to access them is coming in Level 2 later in 2018.

Summary:
• There are numerous ways to access your early retirement funds
• Fully fund your tax advantaged accounts to maximize your wealth
• Don’t worry, the main goal is to save enough to retire, there are plenty of ways to access the money as needed

Your Next Steps:
• Take a look at your current savings. Where does it sit? Tax advantaged accounts, cash, personal brokerage accounts?
• Are you fully funding your tax advantaged accounts? If not, fix that ASAP!
• Start thinking ahead a few years towards your early retirement plan, which approach to access your funds will work best for you?

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