Dreams of early retirement can come true.
The stock market’s near record highs, swelling 401(k)s and other retirement account balances. Many older Americans may feel if they could only tap those funds without penalty, they might have enough to retire a little early. They can, experts say.
The Rule of 55 and 72(t) allows some Americans early access to their retirement funds, experts said. They’ll still have to pay income tax on withdrawals but can skip the 10% early withdrawal penalty people under the age of 59½ usually must pay. At age 59½, the early withdrawal penalty no longer applies.
“It’s true they allow you to withdraw from a qualified account before 59½ to avoid penalty,” said Rob Burnette, investment adviser representative and professional tax preparer at Outlook Financial Center, but he and other advisers still prefer clients look elsewhere before heading down this route.
72(t), especially, is “not as simple as expected,” he said. “It is very complex.”
What’s the 72(t) Rule?
72(t) allows Americans of any age to tap retirement savings without owing a 10% early withdrawal penalty if they commit to taking “substantially equal periodic payments” for at least 5 years or until age 59½, whichever is longer.
A 72(t) applies only to one account. Separate plans must be set up if you plan to withdraw from more than one account.
Once payments begin, you cannot change or stop the payments, not even during a market downturn or if you get a job. Any changes result in the early withdrawal penalty applied retroactively to the very first payment.
72(t) plans may sound easy but calculations to ensure payments are “substantially equal” are complex, advisers said. The IRS outlines three methods you can use to calculate payments.
“Even if you’re off by a few dollars, it could potentially jeopardize ‘penalty free’ and could create penalties from the beginning,” said Aaron Ulrich, owner of Integra Financial Planning, LLC.
What’s the Rule of 55?
To qualify for penalty-free 401(k) withdrawals, you must leave your job in or after the calendar year you turn 55 years old if your employer’s plan allows this. The rule only applies to your current 401(k) plan, not any from other workplaces or IRAs, and the 401(k) must remain with that employer.
Qualifying public safety workers, like police and firefighters, with 403(b) plans are exceptions. They qualify at age 50.
Unlike 72(t), “there’s no commitment with the Rule of 55,” said Jaime Eckels, partner at Plante Moran Wealth Management. People can pause or change payments any time without penalty.
Who Should Use 72(t) or Rule of 55?
A 72(t) is likely only for a “narrow, niche group of people, not widely used,” Ulrich said.
If someone has “high, high (retirement) balances, it could make sense,” he said. “Most people see their best earnings in their 40s and 50s, and market growth can be huge until retirement. But if you have a lot of money in your retirement account and want to retire, maybe it could work.”
But advisers said they usually avoid 72(t) as much as possible because of its rigidity and severe penalties if not perfectly calculated and followed. “I’ve never once used 72(t) in my 21 years to access funds,” Eckels said.
Rule of 55 is more flexible, but eligibility requirements keep the option open to a limited group, advisers said.
If you unexpectedly lose a job and absolutely need money, these can be options, Eckels said.
But even then, advisers said there are often better choices.
What Should Early Retirees Consider First?
Americans considering early retirement should establish different savings buckets, including an emergency fund, a 401(k) and/or an IRA, taxable brokerage account and a tax-free account like a Roth IRA, Roth 401(k) or health savings account (HSA), Eckels said.
Americans pay capital gains tax on brokerage accounts. If investments have been held more than a year, lower long-term capital gains tax rates apply. “Depending on your income, capital gains tax can be as low as 0%, 15% — lower than income tax,” Ulrich said.
Tax-free withdrawals can also be made from Roth or HSA accounts if you need money, Eckels said.
Roth IRA investment earnings can only be withdrawn tax- and penalty-free if you’re at least age 59½ and after the account’s been open at least five years, but contributions can be withdrawn any time, Eckels said. Roth contributions are made with after-tax money.
If you kept receipts for a qualified medical expense, you can use your HSA to “reimburse” yourself for them at any time, tax- and penalty-free, advisers said.
Medora Lee is a money, markets, and personal finance reporter at USA TODAY. You can reach her at [email protected] and subscribe to our free Daily Money newsletter for personal finance tips and business news every Monday through Friday.
