Funding for early retirement

How to Fund Your Early Retirement

Is early retirement a part of your plans? If you can afford it, early retirement certainly has its advantages. You get to leave the working world early and start living life on your terms, and you get to do it while you’re still young and physically active.

Of course, early retirement can bring a number of hurdles, too. One of the biggest is that you have to fund more years in retirement, which could be a drain on your assets. If you spend too much in the early years, you may not have assets left in the later years.

Another big challenge is how you would fund the early years of retirement. If you’re like many Americans, much of your retirement assets may be held in qualified, tax-deferred accounts such as 401(k) plans, IRAs, annuities or others. With most of these accounts, you can’t take withdrawals before age 59½. If you do, your withdrawals are subject to a 10 percent early distribution penalty.

If you retire before age 59½, you may not have access to much of your retirement funds without facing a penalty. Even if you don’t plan on retiring early, this could be a problem. You could be forced into retirement due to disability or job loss.

Fortunately, there are strategies available to help you take income from qualified accounts without paying an early distribution penalty. Below are a few tips to help you create early retirement income:

Early Distribution Penalty Exceptions

While most early distributions from qualified accounts trigger a 10 percent penalty, there are exceptions. Your eligibility for these exceptions depends on the type of qualified plan and the reason for the distribution.

For example, exceptions are often made for distributions related to disability. Your penalties could also be waived if you’re using the money to pay for higher education costs, a home purchase or even medical bills.1 A financial professional can help you determine whether your distributions would be eligible for penalty exceptions.

Rule of 55 Distributions from a 401(k)

The IRS makes another exception specifically for 401(k) plans. Known as the Rule of 55, the exception allows plan participants to take penalty-free distributions from a 401(k) plan if they separate from service from their employer in the year they turn 55 or later.

Keep in mind that this strategy applies only to the 401(k) plan for the employer from which you separate from service. For example, you couldn’t use this rule to take penalty-free distributions from an IRA or a 401(k) plan from another employer.

Roth IRA Contribution Withdrawals

Do you have a sizable amount of retirement assets in a Roth IRA? Your contributions to that Roth were likely made with after-tax dollars. The Roth IRA is a bit unique because you can withdraw your after-tax contribution dollars at any time and for any reason, even before age 59½. However, growth distributions before age 59½ would face taxes and penalties.

Life Insurance Policy Distributions

Finally, life insurance that has substantial cash value could offer another income option. If you have a permanent life insurance policy such as a Bank On Yourself policy with a considerable amount of cash value, you may be able to use those funds to create income before age 59½.

You can start by taking tax-free withdrawals from your life insurance policy cash values, up until you reach your cost basis (the total amount of premiums you have contributed). This amount will be tax-free, since you already paid taxes on those contributions.

Once you reach your cost basis, you can still take an income via tax-free loans from the life insurance policy. Technically, these distributions aren’t taxed because they represent a loan that needs to be repaid. If you don’t repay the loan, the balance is deducted from the policy’s death benefit after you pass away, which makes life insurance a uniquely efficient way to fund your retirement, and still leave a legacy to your loved ones after you are gone.

Planning to retire early? Let’s talk about it! Contact us today to set up a time to speak with one of our retirement income specialists who can help you analyze your needs and develop an appropriate retirement income strategy.

 

1 https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

 

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