Plan your early retirement through 401(k) plans with this guide.
In this article:
- Your Age and 401(k) Early Retirement Withdrawals
- 401(k) Early Retirement Strategies You Can Use to Tap into Your Assets Early
- Tips on How to Retire Early without Touching 401(k) Plans
401(k) Early Retirement Rules You’ll Be Glad to Know
Your Age and 401(k) Early Retirement Withdrawals
Early retirement can’t begin soon enough for some. Of course, setting up a 401(k) retirement plan should result in financial independence at an advanced age.
What happens, though, if you end up retiring early? Would you be able to enjoy your retirement benefits?
Often, 401(k) early retirement questions come to mind for would-be retirees. This is if they plan on retiring earlier than the average person.
This article talks about the penalties and taxes and the methods you can implement to use funds from your assets before the mandated retirement age.
1. Age 55 and Below
Tapping into your employer’s retirement plan at the wrong time can incur a 401(k) early withdrawal penalty. See how much is taxed on 401(k) early withdrawals depending on what age you are at.
Should you wish to retire early during this age range, the government treats early 401(k) withdrawals as taxable income. Therefore, this will incur an income tax.
Early Withdrawal Penalty
There’s also the 10% early withdrawal penalty.
The only times an investor is entitled to tax-free withdrawals in this age range is when they’ve become disabled or make a small deduction for medical expenses. These deductions can cut the value of your withdrawal by as much as half.
You may enjoy this early retirement benefit if a Qualified Domestic Relations Order (QRDO) is used. Lastly, it is applicable if your beneficiary withdraws from your account if you die.
2. Age 55 to 59 and 6 Months
This may be a little bit earlier than the normal or full retirement age, but the same penalties apply. However, note that there are exceptions.
When one leaves employment at or after the year they turn 55, 401(k) withdrawals are still considered taxable income. At this point, however, the withdrawal will be free from the penalty charge.
It then leaves the investor with more money in their nest egg. It may even increase their net worth.
Please note that investors will only be able to withdraw from the 401(k) account of their current job. They will need to roll over funds from their other 401(k) accounts from previous jobs to their current one.
It doesn’t matter if it’s full-time work or part-time work. This includes retirement accounts such as Traditional IRA plans and other retirement plans from previous employment.
3. 401(k) Withdrawal at Age 59 1/2 to 70
The point when one reaches 59 and six months is the time an investor can make withdrawals without penalties from previous works’ 401(k) assets. If one is still working as a full-time employee or doing a part-time job, they will need the guidance of their 401(k) administrator to make withdrawals penalty-free.
Keep in mind, however, the government still considers these withdrawals as taxable income.
4. Age 70 and Above
When an investor turns 70 or older, the IRS mandates the need to make Required Minimum Distributions (RMDs) or regular withdrawals. One can choose to delay these withdrawals until April of the year they retire.
If the investor has a 5% stake in their company, however, they will be forced to take those tax-deferred withdrawals.
401(k) Early Retirement Strategies You Can Use to Tap into Your Assets Early
1. Make Substantially Equal Periodic Withdrawals
The IRS-issued Rule 72(t) allows account holders to withdraw penalty-free. It works as long as they take them in at least 5 substantially equal periodic payments (SEPPs).
This period can run for as long as 5 years. One will need the advice of a specialist for help on how to set up a 72(t) distribution.
Again, the amount withdrawn for early retirement will incur an income tax deduction. It’s advisable to seek the advice of an expert to help avoid incurring a 72(t) distribution penalty if one is thinking of this option.
2. Roll Over Your 401(k) to a Roth IRA
An investor can convert their 401(k) balance to a Roth IRA, then withdraw the money penalty-free. Note though, investors can only tap into these funds five years after they roll them over.
One should make adjustments in their retirement savings if they intend to take this route. It’s better to talk to an expert about this to avoid any mistakes when one decides to roll over a 401(k) retirement to a Roth IRA.
3. Make 401(k) Early Retirement Withdrawals at Age 55
If it’s a possibility to make compromises to one’s early retirement life plans, then one can try retiring at 55. This way, the account holder can make penalty-free withdrawals.
It’s not the same as retiring at 40, but at least one will have more value with their withdrawals and retirement income.
4. Opt for a 401(k) Loan
When there’s absolutely a need to tap into one’s 401(k), it’s possible to borrow around 50% of the total 401(k) balance or $50,000 from the nest egg. It depends on which is lesser.
What’s great about this is that the interest one pays goes back into the 401(k). There are stiff penalties if one leaves their current employment and does not repay their loan within 90 days, however.
This way, the account holder can use some of their 401(k) retirement. They do still need to repay it for future use, though.
5. Make Hardship Withdrawals
For the most extreme needs, an account holder can make hardship withdrawals from their 401(k) if there are provisions for it in the plan. Both the income tax and penalties apply if one is below 59 and 1/2.
This option only becomes available if one has exhausted other loans under the plan and have no other financial recourse to meet the need. An account holder can also only withdraw an amount less than the specific value they need.
Tips on How to Retire Early without Touching 401(k) Plans
The 401(k) plans and other retirement accounts are not there for investors to enjoy anytime they want. They are available so they can have money during their sunset years when they’re already out of work.
Besides knowing how to retire early with a 401(k), an investor may also want to learn how to do it without touching the plan. Here are some tips:
1. Open Your Mind to an Early Retirement Package
Many companies, especially big ones, run an early retirement program, especially to those nearing the end of their service. The amount an account holder receives can vary.
It usually depends on the length of service, take-home pay, position, and age. It is also commonly a lump sum payment equivalent to a year’s worth of salary and more for each year of work.
It can be a golden opportunity to rest and relax, as well as look for an employer one truly likes. Investors now have the option to either take full-time jobs or work part-time in a non-profit organization.
Note, though, it still needs careful consideration. Along with the retirement package is the possibility of a reduced pension benefit.
2. Take Care of Your Health
Health care costs can drain one’s coffers, including 401(k) plans and other savings accounts, in a snap. Early retirees may find themselves in an even bigger problem since they may no longer have enough health insurance coverage.
Thus, investors may ease their worry by increasing contributions to the Health Savings Account (HSA). One can also work with their financial advisor to forecast health care expenses.
The best strategy, however, is still to take care of one’s health. It’s best to be proactive, particularly if one already has pre-existing conditions.
3. Diversify Your Savings
When it comes to early retirement and 401(k), it’s best to be more engaging. Don’t rely solely on the employer’s old-age pension plan or even Social Security.
One is likely to receive Social Security benefits, along with those from a 401(k), and that’s a good thing. What’s better, however, is if the account holder can wait until they reach full retirement age.
It means leaving a job at 65 for those born before 1938, or 67, for those born in 1960 and above. An investor can also increase their benefit up to age 70.
In other words, an investor may end up using their 401(k) plans first if they want to retire early. If one wants to hold off that decision as long as they can, it’s possible to explore other methods of saving:
- Scale down your expenses. Hopefully, by the time one is in their fifties, they’re no longer paying a mortgage or sending children to school.
- Shop for the best savings rate. Sometimes the high maintaining balance may be worth it if one’s parked money also enjoys a high-interest income.
- Consider other investment options such as mutual funds or real estate. Those interested in this just have to make sure they know their tolerance to find more suitable alternative investments.
What Are Mutual Funds? These are pooled funds or securities composed of different asset classes such as bonds or stocks. They allow individuals with a lower budget to start investing.
4. Take Advantage of Compound Interest
For those who are late to the game, but still want to retire early, they can focus on financial choices that can compound interest.
In this method, one adds back the interest they earn to their principal. It then boosts their interest income over time even if the principal amount remains the same.
Learn about the rules for 401(k) withdrawals by age in this video:
A majority of the working population sees retirement as the time their freedom resets. The 401(k) plan is a tool to supply some of one’s needs during retired life.
Tapping into one’s retirement savings before the mandated retirement age can reduce how much it can supply for them later on. If an account holder can accept this caveat, their 401(k) can be a good resource for early retirement.
Were your questions about 401(k) and early retirement answered in this article? If you have more to ask, please write them in the comments section.
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Editor’s Note: This post was originally published on June 22, 2018, and has been updated for quality and relevancy.