By Dr. Jim Dahle, WCI Founder
If you read the fine print on your IRAs, 401(k)s, and 403(b)s, you've probably discovered that the government wants you to use the money for retirement and also that the government feels that retirement shouldn't start before age 59 ½.
But what if you want to retire before age 59 ½? How can you get to your money without that pesky 10% penalty that comes with taking money out before age 59 ½?
Here are some things to think about if you want to withdraw your retirement money before you turn the age when the government thinks you should retire.
8 Tips for Getting to Your Money Before Age 59 ½
#1 Burn Your Taxable Account First
Your taxable account is your least tax-efficient way to invest. Yes, it has its tax benefits, but these pale in comparison to IRAs and 401(k)s, especially when you consider the additional estate planning and asset protection benefits of a true retirement account. Most experts agree that an early retiree ought to hit up their taxable account before diving into their tax-protected ones for a number of reasons. First, you don't pay any tax on your basis, which might be quite high. Second, long-term capital gains are only taxed at 0%-20%, likely much less than your IRA withdrawals. Last, it leaves your IRA money to continue to compound at tax-free rates.
#2 Drain That 457
A 457(b) is a tax-protected account available to many docs who work for university hospitals. If you have a 403(b), you ought to look and see if you have a 457 too. It allows you to squirrel away another $23,000 a year [in 2024] into a tax-protected account. Its biggest downside is that the money is technically subject to your employer's creditors. But that comes with several upsides. First, it gives you a tax break just like a 401(k) or 403(b). Second, it isn't subject to YOUR creditors. Lastly, you can raid it as soon as you separate from your employer without having to worry about the age 59 ½ rule. In fact, you probably should since it isn't quite as separate from your employer's money as your 403(b) account is. If you don't want to spend the money, you can also roll it into an IRA if it's a governmental 457(b). That, of course, makes it subject to the Age 59 ½ rule, so don't do it if you want to spend the money before then.
More information here:
#3 Take Advantage of the SEPP Rule
The Substantially Equal Periodic Payments (SEPP) rule is the little-known exception to get into your IRA as soon as you retire. You basically “annuitize” your IRA from the time you retire until 59 ½. Your life expectancy is calculated, and you then must take out an equal amount each year equal to the balance of the IRA divided by your life expectancy. Once started, you must continue to take these withdrawals for at least five years or until age 59 ½. When you do this, you DO NOT have to pay the penalty (but, of course, you do have to pay taxes due on a tax-deferred account).
#4 Don't Forget the Exceptions to the Age 59 ½ Rule
Per the IRS, you can take out the money without paying the 10% penalty for the following reasons:
- Unreimbursed medical expenses > 7.5% of your Adjusted Gross Income (which may not be that high if you're retired)
- Pay for medical insurance
- Disability
- Inherited IRAs (if your parent leaves you their IRA, you can take out the money before you get to 59 ½)
- Qualified Higher Education Expenses (for you, your kids, or your grandkids)
- A first home. Keep in mind the IRS definition of a “first home” is that you haven't owned one for the last two years. Also, it doesn't have to be YOUR first home; it can be your kid's or grandkid's first home too. See how this works? You pull out $10,000 from your IRA to pay toward their home, and they gift you $10,000 for Christmas. No 10% due. Ethical? Perhaps not. Legal? Certainly. Keep in mind there is a $10,000 limit
- New child or adoption ($5,000 limit)
- IRS levy
- Reservist distribution: A military reservist can withdraw money while activated without paying the 10% penalty
- Terminal illness
- Thanks to Secure Act 2.0, if you've been the victim of domestic abuse, you can take out up to $10,000 or 50% of the balance, whichever is less, out of an IRA or a 401(k) without having to pay that 10% penalty. You can also repay the money for a period of three years. This begins in 2024.
Note that the rules for IRAs are slightly different from those for 401(k)s and other qualified plans.
#5 Don't Forget the Stealth IRA (Your HSA)
After age 65, a Health Savings Account can serve as just another IRA. Withdrawals from that HSA for qualified medical expenses are always tax and penalty-free.
More information here:
How I Went from a Negative Net Worth in My 30s to Early Retirement
#6 Roth IRA Contributions
Unlike traditional IRA contributions and earnings on either type of IRA, all contributions to a Roth IRA can always be taken out tax- and penalty-free. In fact, some people even use their Roth IRA as an emergency fund initially because of this.
This can apply even to Backdoor Roth IRAs, which is the only way most practicing physicians can make these contributions. Be aware of the five year rule if you do your Roth IRA contribution via the Backdoor process, which basically makes you wait five years after the conversion step to pull money out tax and penalty free. Frankly, if you make enough that you have to make your Roth IRA contributions via the Backdoor Roth IRA process, you probably make enough to build an emergency fund easily without keeping it in a Roth IRA.
I would also be hesitant to touch a Roth IRA any earlier than you must. Those tax- and penalty-free distributions are tempting, but keep in mind that in terms of maximizing your estate, the Roth IRA is often the LAST account you would want to touch. A stretch ROth IRA is the best account for your heirs to inherit.
#7 401(k) Loans
All right, I can't really recommend this one. The problem with a 401(k) loan is that you have to pay it back immediately if you separate from your employer, which is kind of the point of retirement. But it does allow you access to your money before age 59 ½ . . . as long as you keep working at least part-time.
More information here:
Are Physicians Who Retire Early Abusing the System That Made Them Rich?
#8 Cash Value Life Insurance
This is another one I can't recommend. If you were suckered into a cash value life insurance policy years ago and it now makes sense to keep it (as it often does AFTER 10-20 years), the cash value can be accessed to pay for early retirement expenses without any concern about taxes or penalties. Life insurance salespeople LOVE to point out this benefit of their policies. Despite this benefit, life insurance is still a lousy investment due to the high fees, poor returns, and overly expensive insurance components, so don't go buy a policy to fund your early retirement. You're likely far better off with a plain old taxable account invested in index funds. Don't mix insurance and investing.
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What do you think? When do you plan to retire? What resources will you use first in retirement? Comment below!
[This updated post was originally published in 2011.]
Can my wife who’s a teacher and has a 403B also have a 457?
And shield the rest of her salary for retirement in that?
If someone has access to both a 403b/401k and a 457 they can invest $17,000 2012 into both (plus catch up if applicable). But we have no way of knowing if your wife has access to a 457 Z.
The employer has to offer her a 457. She can’t just go to Vanguard or Fidelity and open one.
A word of caution about 457 plans
My 457 plan does not permit a rollover into a IRA upon employment termination or retiring.
When employment terminates, an election has to be made to be made upon when and how to recieve payments ( quarterly, annually,lump-sum etc).
These payments would be fully taxable as oridinary income.
As a 35 yo…chances are, I will not be with same employer for the next 30 yrs and will likely start recieving payments during my working years (payments taxed at the highest marginal tax rates).
I would therefore suggest holding bonds or other tax-inefficient assets and assets with the least growth/appreciation potential ( if such assets are part of your overall portfolio) in 457 plans.
You must have a “private” 457. Most are government 457s and are eligible for rollover to an IRA, 457, 403b, 401K etc upon your termination. Yours may still be worth using as you can defer taxes with it, but the prospect of taking out a fat lump sum and paying taxes on it during your peak earning years is pretty unappealing.
My wife is 5 years older than me. Does that mean that we will be able to start using our funds in our SEP IRA when she is 59.5 and I am 54.5?
You don’t have an “OUR” SEP-IRA. She has one and you have one. You can tap hers at 59 1/2 without penalty. See above for how you can get to yours.
While I whole heartedly support your position of not buying whole life, with the purpose of using it as an investment, there are better things to do with it if you have had it for many years and now are close to retirement. You can use the cash value and dividends, by taking advantage of a 1035 exchange to totally fund a Long Term Care Policy, depending of course on the size of the policies. In my case, my 35 year old policy that cost me about $23 a month is now totally funding itself and my LTC policy.
These policies are generally worth holding, even if only as an investment, if already had it for 35 years. A 1035 into a LTC policy is another good option.
Bravo to Shawn
Be very careful about 457. There was nowhere to roll my 457 from a “private non-profit hospital”. Each subtype of 457 has its own set of rules. Been there, learned that, paid the taxes on all of it .(although my bracket really hadn’t changed that much, it was indeed HIGHER when I separated from service) {although it did grow tax-deferred, somewhat ameliorating the pain}
I was just personally contacted by the benefits lady in HR double-checking to make sure I “really wanted to” contribute to my 457. She said that I was only one out of 50,000 employees putting in $18k this year. Kind of scary.
I have no idea what you mean here: 3) Take advantage of the SEPP rule.
Can you spell it out for me? Literally and figuratively… Sorry but I have no idea what this is referring to.
The SEPP rule allows you to take out substantially equal payments each year from the year you start until age 59 1/2 without having to pay the penalty.
Can Roth 401k funds be accessed in same manner as Roth IRA funds? How about Roth 401k funds that are the result of an in-plan conversion? If the 401k is rolled over to an IRA, would that change anything? Lots of questions I’ve got and any answers would be helpful.
The rules are slightly different. For example, you can get to 401(k) money after age 55 penalty-free but only after separation from the company. Roth and tax-deferred funds have the same rules inside the 401(k), no matter how you did the conversion.
With a Roth IRA, you can take out the principle at any time penalty free, but not converted amounts. You also have to wait until 59 1/2 even if you retire early unless you SEPP it.
To be sure I understand what you’re saying here….
You can get to *either* a Roth 401(k) *or* a traditional 401(k) after age 55 penalty-free (after separating from the company)? My understand was that this was applicable to just the Roth 401(k).
Yes, you can get to both penalty-free. You’ll owe taxes on the traditional 401(k) of course.
Can Roth 401k funds be accessed in same manner as Roth IRA funds? How about Roth 401k funds that are the result of an in-plan conversion? If the 401k is rolled over to an IRA, would that change anything? Lots of questions…. and any answers would be helpful.
Could I terminate a Solo 401k plan that has a Roth subaccount funded by “Roth Deferrals” and “in-plan Roth rollovers”, roll those Roth 401k funds into a Roth IRA, and then access the funds – up to the tax basis – without paying any taxes or penalties? All this prior to age 55. Any cites and references would be appreciated.
Thanks again for the great resource you provide.
I don’t know. That’s a good question. I’m not 100% sure but I would bet not because they were originally 401(k) contributions, not Roth IRA contributions. If there is a reference, it might be in Pub 590.
https://www.irs.gov/pub/irs-pdf/p590b.pdf
I have a solo 401k which allows in-plan rollovers and out-of plan roth rollovers. I’m also looking at ways to to access money prior to age 59.5. I’ve decided to do an out-of plan roth rollover every year with an after-tax contributios and out-of plan rollover to a roth ira on the same day. The entire converted amount would then be considered a nontaxable conversion. Then, per the roth withdraw rules, in the future if I have no taxable conversions or all my taxable conversions are older than 5 years, I could withdraw all my contributions to the roth ira, nontaxable conversions to the roth ira, and taxable conversions to the roth ira tax free and penalty free at any time.
I chose an out-of plan rollover because you can easily withdraw from a roth ira whereas you cannot directly withdraw from a roth 401k.
Presumably, if I did an in-plan rollover in the 401k and a future rollover of the roth 401k to roth ira, withdraws from the roth ira would operate the same. Your original roth 401k contribution amounts and in-plan roth rollover amounts would be documented on the 1099-r for the roth 401k to roth ira rollover.
Tell us about your solo 401(k). Who’s the provider that allows out of plan Roth rollovers? Is it a custom-designed plan or off the shelf?
I had a Fidelity solo 401k plan and I hired Pinnacle Plan Design to amend the document to allow in plan and out of plan roth rollovers. This in combination with a defined benefit plan will enable large pretax and aftertax tax deferred contributions
As far as I’m aware, no prototype solo 401k allows in plan or out of plan rollovers.
How much did/do you pay Pinnacle (both with and without the DB plan costs if you can)
I didn’t know about the penalty-free withdrawals for medical insurance — now that is a nice thing to know. Pays for the price of reading!
Hi WCI,
When making an early withdrawal from your Roth IRA that has been funded via the backdoor method and not via a direct contribution (because you make too much), do these backdoor contributions still count as contributions and is there a certain way that you would approach the withdrawal process to avoid being taxed on your contributions in addition to your earnings? There’s a sction of the withdrawal form that askes for your tax witholding elcetions for both federal and state – what do you elect for these? Also as a side note, if your account has lost money and the current value is less than the amount you’ve contributed does this change the withdrawal approach? TIA
Don’t withhold anything, but do look up the five year rules with regards to using Roth money.
Hopefully you don’t have any losses by the time of withdrawal!
All good ideas for beating the 59 ½ rule. I would say don’t put all life insurance into the same bucket. That would be like saying all investments into X is bad. I have used a private placement product to accumulate money and take what was in my taxable account an put it inside the insurance rapper. The expenses loads including cost of insurance and taxes, commissions are less than what I would pay in taxes. I do agree that a whole life policy is not the answer if you are looking for tax free dollars from the policy.
I recently spoke about this subject at the American College of Emergency Physicians (AAPL) conference. You can download the talk from my website.
AAPL?
My understanding of the SEPP rule is that you must take equal distributions for at least five years, even if those five years end after you are 59 and 1/2. If you begin a SEPP at age 57, you are committing to that SEPP until 62.
Tell me if this is a reasonable strategy. I am considering going part-time at my position at age 56 but using a SEPP on a SEP IRA that represents about 1/2 of my retirement savings to provide the difference in income going part-time. I would commit to the SEPP until age 61 but could access my other retirement accounts unrestricted when I turn 59 1/2 (when I want to be fully retired).
That’s right.
I actually never thought about whether you could just do it with one account. I suppose you probably could. Let me look it up….
https://www.irs.gov/retirement-plans/substantially-equal-periodic-payments
https://www.irahelp.com/forum-post/30239-divide-ira-and-then-immediately-start-sepp-one-accnt
Yes you can.
SEPP comes under rule 72(t). I used it to buy an annuity when I hit 48 – and have never looked back. Also, I have never worked again.