Yes, You Can Retire Early!

Brent Bell, CFP®, MS

by Brent Bell, CFP®, MS

Yes, You Can Retire Early!

Yes, You Can Access Your Retirement Plan Assets!

No, You Don’t Have to Pay a Penalty!

Early Retirement and the Early Distribution Dilemma

Picture this: You’re 52 years old, you’ve been saving diligently for years, and you have enough money stashed away to retire whenever you want. You have attained the ultimate goal of financial freedom.

The problem is, the only assets available to you are from your IRAs or your employer’s retirement plan and you’re too young (under age 59 ½) to withdraw assets without incurring some hefty tax penalty for early distribution. If you were 55 or older before retiring, you would be able to claim a separation of service strategy for withdrawals from your employer’s retirement plan. But that’s three years away and you’re ready to retire now – there’s no way you’re working another year, let alone three!

Great news: There is a strategy for you to access your assets penalty free.

The 72(t) Distribution Basics

That strategy is called a 72(t) distribution (i.e., Substantially Equal Periodic Payments) and must be distributed until you reach age 59 ½ or five years, whichever is longer. There are three distribution methods to choose from to meet your liquidity needs based on three different calculations that use your IRA account balance, your age, beneficiary’s age, a reasonable rate of return, interest rate (federally determined), and a life/mortality table.

The calculation isn’t too tricky, but I recommend coordinating the strategy used between your financial planner, accountant, and the custodian of your account. Any changes made to your distributions could possibly result in you incurring that substantial early distribution penalty you’re trying to avoid.

Distribution Methods

  1. Amortization
  2. Annuitization
  3. Required Minimum Distribution

The three methods to determine your Substantially Equal Periodic Payments are the Amortization method (similar to a mortgage), Annuitization method (calculated like an annuity), and the RMD method (similar to the Required Minimum Distribution method used when you reach age 70 ½). Each one has its advantages, such as the Amortization and Annuitization methods being fixed-payment amounts that never change from year to year and typically result in the largest distributions. On the other hand, the RMD method is a lesser amount that is recalculated annually and fluctuates based on your account balance (and reduces the risk that you will deplete your principal).

Keep in mind, the IRS allows you to make a one-time switch from either the Amortization or the Annuitization method to the RMD method if you believe the distributions are an excess amount and want to preserve your principal. You cannot make any other type of switch between chosen methods.

Advanced Planning Strategies

There are also a few advanced planning strategies that can be used in conjunction with a 72(t) distribution whether or not you’re in actual need of cash flow. A 72(t) distribution could lower your principal balance in pre-retirement years before you are required to take RMDs (age 70 ½), resulting in a lower RMD during retirement, potentially lowering your marginal tax bracket, and possibly lowering the amount of your Social Security benefits that are taxed. Furthermore, incorporating this strategy with a Roth conversion strategy would increase your tax-free bucket creating the potential for tax-free growth.

In the end, I would confirm these strategies with your accountant before initiating, but the overall goal is to minimize the tax that is paid over your lifetime and decrease the tax burden you may have in years where your marginal tax rate is projected to be higher than others.

You’ve Earned It; Let Us Handle Your Concerns from Here

The bottom line is that if you are capable and ready to retire, there may be challenges if your assets are all in tax-deferred retirement accounts. Happily, there are solutions to help make your transition to retirement smoother — and more importantly, achievable. You’ve dug deep and grinded to save diligently to get you to this point, and what an accomplishment that is!

Let us take it from here and implement the proper financial planning strategies to ensure your assets can provide you an efficient and sustainable retirement income.