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The day has finally arrived.  After a long and diligent career you are ready to retire! You listened to the advice over the years; you saved as much as possible and controlled your expenses. All of the hard work and discipline has paid off when you finally see that magic number in your 401(k) account that will allow you to retire! The best part? You are only 55; you are going to retire early and all you have to do is pay a staggering 10% penalty for early withdrawals!

That story, very quickly, lost quite a bit of its luster with the realization of penalized early withdrawals. What happened? What is the 10% penalty on your saved and invested retirement dollars? Unfortunately premature withdrawals from qualified accounts, such as a 401(k), are penalized until you are 59 ½. While this penalty can alter our picture it does not mean that participants who have worked and saved for an entire career need to be disheartened. There are still ways to enjoy your retirement early rather than resign yourself to work until you are 59 ½ to avoid penalty.

Allow me to introduce you to the IRS provision, Rule of 55. Under this rule if you have been terminated or quit the service of your employer you may take penalty free withdrawals from your most previous employer sponsored 401(k) plan. If your 401(k) is traditional rather than a ROTH, you will still need to pay taxes on your withdrawals – but the penalty free aspect gives you the flexibility to potentially retire early. It is important to remember that this does not apply to that miscellaneous 401(k) from your employer 10 years ago that you never rolled over. The Rule of 55 also does not apply to any IRA’s you have invested elsewhere. Depending on your circumstances you will want to consult with your financial advisor regarding the amount you may need those first few years of retirement prior to turning 59 ½. Depending on each individual’s situation it may be prudent to roll as much qualified money into your current 401(k) plan prior to terminating service. This way all of your dollars are accessible if necessary.

As great as this is to getting us back on track for an early retirement, not everyone has the benefit of an employer sponsored 401(k) plan. Perhaps your current employer does not even offer a plan and you have moved all of your qualified investable assets into IRA’s already. Fortunately, there is a solution for this situation as well. Please welcome the IRS rule 72(t) also known as the Substantially Equal Periodic Payment rule, or Code 72(t), Section 2.

Rule 72(t) allows potential early retirees to take withdrawals from qualified accounts such as an IRA prior to age 59 ½ and does not have the minimum age 55 requirements like the Rule of 55. However this rule does not provide the same level of flexible withdrawal rates. Utilizing the Rule of 72(t) has a few different ground rules that must be followed.

  • Once distributions start they must be taken for whichever amount of time comes later, at least 5 years OR until reaching the age 59 ½. If you start at age 58, you will have to take the equal distributions until age 63 (Total of 5 years even though you have turned 59 ½). If you start at age 55, you will have to take the distribution schedule until turning 60 (Total of 5 years even though you passed age 59 ½).
  • There are three ways you can calculate your distributions, Amortization, Annuitization and Required Minimum Distribution.

You will want to consult your financial professional to determine which option for calculation will be best suited for you. Once the distributions start you will have to maintain at the same level until the time requirement is met. Based on your situation you would not want to start this distribution schedule with a payout that is drastically below your needs in retirement, you also would not want to over withdrawal either. The standard strategy is typically 4% withdrawals on retirement accounts during your retirement years.

Whatever choice you decide to make our advisors are readily available to help walk you through these different situations. A quick planning session can make the world of difference as well as provide confidence in the path you choose

Taylor Knopf
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