Many people in their fifties have saved in their 401(k)’s and IRA’s, may have a company pension plan, private savings and are ready to retire. Congratulations, you have a well-earned permanent vacation for the next several decades.
But, wait! You can’t pass go and withdraw your tax deferred savings without addressing the IRS’ 10% penalty imposed on withdrawals prior to age 59 ½.
And, let’s be clear, the 10% penalty is in addition to ordinary income taxes due on the sums withdrawn.
Failure to utilize IRS approved exceptions to the penalty and solid retirement planning could cost you dearly. We don’t want that to happen. You’ve worked too hard for your days in the sun.
Here are a few tips and techniques that when utilized in a well-crafted retirement income plan can help you side-step this pesky penalty.
401(k) withdrawals: If you are at least 55 years old and are leaving your job for any reason (quit, fired, position terminated or retiring) you can withdraw monies from your 401(k) without the 10% penalty.
With a well thought out retirement income plan you can determine which funds (some or all) to leave in your 401(k) to withdraw for pre-59 ½ income needs and which you may wish to set aside to help grow for future withdrawal after the 59 ½ penalty is gone.
Rule 72(t): IRS rule 72(t) allows for pre-59 ½ penalty free IRA withdrawals. The IRS offers three different formulas one can employ to determine a stream of Substantially Equal Periodic Payments from their IRA to avoid the 10% penalty. Once you begin taking income from an IRA using rule 72(t) you must continue the withdrawals for five years or until age 59 ½ - whichever is longer.
A common mistake made on this strategy is to subject the entire IRA account balance to the formula, often taking greater distributions than are needed and unnecessarily depleting the account balance. You can break your IRA into two IRAs – one you will apply rule 72(t) to and take withdrawals from. The other you can set aside to grow for retirement income after the required term of the 72(t) payments.
You can utilize the three 72(t) formulas to calculate how much of a lump sum to assign to an IRA so that the substantially equal periodic payments match the amount of monthly income you need. (Note: Don’t try this at home – seek out a qualified retirement planning professional for help. Also, seek a qualified tax opinion).
Roth IRA: Depending on when you set up your Roth IRA account, you may be able to access the account balances for retirement income without taxes or the 10% pre-59 ½ penalty. A review of your pre-59 ½ income needs can be coordinated with your Roth and other retirement accounts.
Non-IRA savings: If you have savings and/or investment accounts funded with after-tax dollars you may be able to utilize those assets for retirement income before age 59 ½. While there may be capital gains on a portion of the investments, the tax treatment for their liquidation is more favorable than absorbing ordinary income tax and a 10% penalty on IRA funds.
The roadmap to retirement is different for everyone. A well-crafted plan helps make the journey safe and pleasant, and you deserve this.
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© Jane B. Smith, CFP®