Retirement Withdrawals Before 59 1/2, Without a Penalty?



I’m going to show you how to take retirement withdrawals from your retirement accounts before you turn 59 1/2, and do it without paying a penalty.

You may be thinking about retiring early, but may not be sure exactly how to do it. If you’re like a lot of people you probably have a most of your retirement savings in tax deferred accounts like IRA’s and 401k’s. We all know since the time we got into these accounts that we couldn’t touch the money until we turned 59 1/2 without getting hit with a 10% penalty.

Well, there are actually 4 ways that you can take retirement withdrawals before 59 1/2 without paying the 10% penalty.

The first is the Age 55 rule from a qualified plan.

If you separate service from your company on or after your 55th birthday, you can access the money in your company sponsored retirement plan without paying the 10% penalty that normally would apply to early distributions. This rule only applies to company sponsored retirement plans like your 401k. Once you rollover to your IRA, you no longer have this option available. As with any tax deferred account distribution, ordinary income taxes will still apply, but the 10% penalty will be waived.

Here’s how it works:
Let’s say you have a 401k with $500,000 in it and you retire at 56. You figure you need about $50,000 to get you through the next 3 1/2 years. So you take a penalty free distribution from your 401k for the $50,000, then rollover the remaining $450,000 into a self directed IRA to continue the tax deferral on that portion.

Next is Regulation 72t.

Regulation 72t refers to a section of the IRS tax code that allows for penalty free withdrawals from IRA accounts. Whereas the age 55 rule applies only to qualified employer plans, regulation 72t is just for IRA accounts.

Again, as with any tax deferred retirement account distribution, you still have to pay the taxes, but what we’re talking about here, is how to avoid the normal 10% penalty.

You can elect 72t at any age as long as you follow the 3 rules.

    1. The payments must be “substantially equal”.
    2. You must use one of the three distinct methods of calculating what your annual payment is each year.
    3. Your Payments must continue for 5 years or until you turn 591/2 whichever occurs later.

Regulation 72t is a complex tax strategy and should not be implemented without seeking appropriate advice from a qualified financial professional.

Take a loan

Not my favorite, but another option that may be available is to take a loan from your 401k account before you retire.

401k’s generally allow you to borrow 50% of your account value up to a maximum of $50,000. One advantage is that you don’t have to pay taxes on the loan amount, however, the disadvantage is that you lose the growth on your money. Before you do this, check with your plan provider to make sure you can keep the loan open after you retire. Even if your employer does allow you to keep the loan after you retire, it will likely prevent you from rolling over your 401k to an IRA.

Also, make sure to keep up on your payments, otherwise the outstanding balance of the loan will become taxable and may be subject to penalties if you are under age 59 1/2.

After Tax Distributions

You may have money in your company retirement plan that has already been taxed. If you do, this can be another source of money that you can access before 59 1/2.

The after tax portion of your account consists of two parts. The portion that you contributed after tax, and the earnings on your after tax contributions that have not been taxed. Even though the IRS rules allow you to roll the entire account over to your IRA. If you roll over after-tax contributions you will be required to keep track of what portion of every future IRA withdrawal is taxable and what part is non taxable. We don’t recommend this.

The preferred method is to rollover all of your pretax money to your IRA account, and then take a check for the portion of your account that has already been taxed. When you receive this check it is a non-taxable event. This money has already been taxed and therefore you can do whatever you want with this money.

Depending on how much you have in your after tax portion of your account, this can be another great way to get access to some of your money, not only penalty free, but tax free as well, in order to fund an early retirement.




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About the author

William G. Lethemon III is an Independent Financial Advisor with LPL Financial. Bill lives in Bloomfield Michigan with his wife and 2 children. He enjoys a very active lifestyle. As an avid runner Bill has run in several Marathon’s and half Marathon’s. He also enjoys mountain and road biking, Skiing, scuba diving and sailing.