Have you used qualified plans such as 401(k)s, IRAs, annuities or others to save for retirement? You’re not alone. These accounts are popular because they allow you to accumulate assets without paying taxes on the growth. In most cases, you avoid taxes until you take distributions. In the case of a Roth IRA, you may never pay taxes on your growth or distributions.
Of course, the trade-off of this tax-favored treatment is that you must wait until age 59½ before you can take distributions from a qualified plan. If you take distributions prior to age 59½, you may face a 10 percent early distribution penalty.
This could be problematic if you retire before age 59½. For example, you could get laid off and 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. Or you could simply be ahead in your savings goal and decide to retire early.
No matter the reason, early retirement presents a few challenges. One of the biggest is generating income from your qualified plans without paying early distribution penalties. Fortunately, there are a few strategies to help you accomplish this objective. Below are four ways you can take income from your qualified accounts before age 59½:
Early Penalty Waivers
The IRS does allow some exceptions to the early distribution penalty. 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, 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
Another strategy applies specifically to 401(k) plans. The IRS offers 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
One unique strategy is to 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 Carstens Financial Group. We can help you analyze your needs and develop a strategy. Let’s connect soon and start the conversation.
Licensed Insurance Professional. This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
16697 - 2017/5/23
Carstens Financial Group focuses on providing comprehensive asset management, estate planning and life insurance solutions. Allow us to help you secure your financial future.