Do much of your retirement assets exist in qualified accounts such as 401(k) plans, IRAs, annuities or other tax-deferred vehicles? These accounts are popular because they allow you to accumulate assets without paying taxes on the growth. In most cases, you aren’t taxed until you take distributions from the account.
The trade-off for tax deferral, however, is that you can’t take distributions before age 59½. These accounts are meant to be used for retirement savings. The IRS has set 59½ as the earliest possible age to take retirement distributions.
Of course, this can be a challenge if you retire before age 59½. Even if you have no plans to retire early, it’s possible that you may need early retirement distributions. For example, you could get laid off and then decide to retire early. You might accept an early buyout from your employer. You could suffer a disability or other health emergency that forces you to leave your career early.
No matter the reason, early retirement presents a few challenges, not the least of which is generating income from your qualified accounts. Fortunately, there are a few strategies to help you accomplish this objective. Below are four steps to consider to create income in the early years of your early retirement:
Early Distribution Penalty Exceptions
Technically, there’s a 10 percent early distribution penalty on distributions from qualified accounts before age 59½. However, it’s possible that you may be able to have the penalty waived. The IRS does grant exceptions in some circumstances. Your eligibility for these exceptions depends on the type of qualified plan and the reason for the distribution.
For example, exceptions are usually allowed for distributions related to disability. Your penalties could also be waived if you’re using the money to pay for higher education costs, home purchases or even medical bills.1 A financial professional can help you determine whether your distributions would be eligible for penalty exceptions.
Rule of 55
Another strategy applies specifically to 401(k) plans for employees who leave their job at age 55 or later. The strategy utilizes an exception known as the Rule of 55. It 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? You could use those assets to create income before age 59½. With a Roth IRA, you can withdraw your contributions before age 59½ without facing penalties or taxes. Since Roth IRA contributions are made with after-tax dollars, they’re not subject to taxation or penalty.
Life Insurance Loan Distributions
You can also use life insurance cash value to create income. If you have a permanent life insurance policy that has a substantial 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 loans from the life insurance policy. Technically, these distributions aren’t taxed because they represent a loan that has to be repaid. If you don’t repay the loan, the balance is deducted from the policy’s death benefit after you pass away.
Ready to plan a strategy for your early retirement income? Let’s talk about it. Contact us today at Spicer Wealth. We can help you analyze your needs and develop a strategy. Let’s connect soon and start the conversation.
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