Early Retirement: How to Withdraw Retirement Funds Penalty-Free Before 59

Early retirement
Early retirement

By David Ning

One of the biggest challenges for early retirees, aside from needing to save enough extra money that it can last though a longer retirement, is that there are early withdrawal penalties on most pre-tax retirement accounts if you fail to obey the rules. That complicates matters for early retirees who want to defer taxes on their retirement savings by contributing to a 401(k).

Luckily, there are many ways for early retirees to withdraw funds without triggering a penalty. Here are some retirement planning suggestions if you are trying to exit the working world before the traditional retirement age:

Consider substantially equal periodic payment (SEPP) programs. Starting a SEPP program can allow you to withdraw funds from your pre-tax IRA and 401(k) accounts before you turn 59½ without paying a penalty. A SEPP program can be started for an IRA at any time, as long as you keep it going for at least five years or until you are 59½, whichever is longer. There are three different ways to calculate how much you need to withdraw, and all of the earnings will be subject to income taxes. But this type of withdrawal is not subject to the early withdrawal penalty.

Early 401(k) withdrawals if you retire at 55 or later. Whether you quit, retire, or are fired, you can withdraw penalty-free money from your 401(k) if you are at least 55 when you leave the job. However, you cannot take penalty-free early withdrawals from previous employers if you left that company before you turned 55. The workaround, of course, is to move the money into your current employer's 401(k) before you quit if you need access to the funds early.

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Withdraw money from a Roth IRA. It's generally best to delay Roth IRA withdrawals as long as possible because the money can generally be withdrawn tax free in retirement, but you can access contributions to your Roth IRA at any time. However, the portion of your Roth IRA balance that comes from earnings will need to stay in the Roth IRA until you are 59 1/2 if you want to avoid penalties.

Do a Roth conversion and then wait five years. Another way to access your money without paying a fine is to convert your pre-tax funds to a Roth and then wait five years. You'll need to scrutinize the numbers to make sure a Roth conversion is best for your tax situation. If you time the conversion correctly in a year when your income is low it can significantly reduce your tax liability.

Use a taxable investment account. If your goal is to retire long before your 60s, you'll probably need to do some of your saving and investing in a taxable investment account. This money can generally be withdrawn and spent at any age without penalty. Just make sure you take into account that you may need to pay capital gains taxes on your gains when you sell your investments.

You will encounter many obstacles to early retirement, but trying to withdraw money from your investment accounts shouldn't be one of them. If you need to tap your retirement accounts early, take steps to avoid the early withdrawal penalty.

David Ning runs MoneyNing, a personal finance site that shares money moves you can make to significantly increase your chances of having a comfortable retirement. He likes to share simple changes that anyone can make, such as picking the best online savings account and figuring out whether a 0 percent balance transfer credit card makes sense.

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