Early Retirement Withdrawal
Jun. 8, 2017 Article

Early Retirement: How Early Is Too Early?

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Many people desire to retire earlier than they originally expected. However, retiring early can have tax consequences. How early is too early to retire? That depends on which retirement accounts you plan to withdraw from.

Advisors generally recommend that individuals wait until at least age 59 ½ to retire, as taking premature distributions may result in a 10 percent penalty in addition to normal taxes withheld. The exception to this rule is Roth accounts. Because they are funded with after-tax contributions, the principal contributed to Roth retirement accounts may be withdrawn at any time and is not subject to the early withdrawal penalty or taxes, assuming the Roth account has been open at least five years.

When considering whether to retire early, estimating your approximate life expectancy will help determine how much you may need during retirement. For example, a married couple who both retire at age 65 may need to support themselves for more than 30 years in retirement.

Applying an estimated rate of return on your portfolio (based on historical averages) may help you determine if your funds may potentially  last long enough to support you through your life expectancy. 

If you are not at least age 59 ½ when you begin taking withdrawals from IRAs or 401k accounts you are subject to pay a 10 percent penalty. However, if you participated in a company retirement plan, such as a 401(k), and were 55 years or older in the year you left your job, you may qualify to take withdraws without incurring the early distribution penalty. The rule is sometimes called the “age 55 rule”.

You can leave the money in your company plan and take your withdrawals from there. The reason is distributions from your company plan, when you leave the company in the year you turn age 55 or later, are not subject to the 10 percent early distribution penalty if you no longer work for that company (or what the tax code refers to as “separation from service”).

If you are under age 59 ½ and need to take withdrawals from an IRA, there is what the IRS refers to as “Substantially Equal Periodic Payments” or the “72(t) exception”.  In that case, you are allowed to make withdraws at least once a year and must keep taking withdrawals for at least five years or until you reach age 59 ½, whichever is later. Remember, though, in either of these withdraw exceptions, it is only the penalty you are potentially avoiding. The distributions would still be subject to federal income taxes.

Finally, it is important to take into account your personal goals for retirement. Many advisors recommend clients do not withdraw more than 4 percent per year. By that rule of thumb, if you have $1 million in retirement assets, your annual withdrawal amount should not exceed $40,000, including any applicable taxes.

For help determining if early retirement is right for you, please contact your advisor.