When are retirement accounts accessible?

[newAndImproving]

I listened to a podcast recently and got the impression that there was a way that 401k/Roth funds were available before 59 1/2. Is that correct?

I am close to maxing out my retirement contributions each year, but haven't because the availability of the money for use at any age is appealing. It seems that putting funds in a place where you cannot access it does not make sense for someone who hopes to retire early.

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Maybe I can do a (very rough) example of what I have tried to explain:

Salary: $100k/year
Expenses: $30k/year
Assumption: 25% effective tax rate
Flaw: does not account for impact of access to Roth account occurring at age 55.

Option A: $19k/year to Roth account
Outcome: $26k/year is saved outside of retirement accounts. This money is accessible at any time. $19k/year in the Roth account grows tax free but is inaccessible until 55.

Option B: No retirement contributions
Outcome: $45k/year is saved outside of retirement accounts.
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Is the best answer maxing your retirement accounts and then you "just" have to save enough to make it from your age at retirement to when you can start drawing on those funds?

 

[N02L84ER]

Some 401k plans allow for penalty free access if you retire from the company the year you turn 55. Not all plans allow penalty free access at that age. You must check your company's plan.
Roth contributions are allowed to be withdrawn without penalty at any time. Roth conversions have a 5 year waiting period before they become penalty free before age 59.5. Roth earnings will have a penalty if withdrawn before age 59.5.
Option A looks better to me. Each year after retirement you could pull $26K from taxable and 4K from Roth contributions to meet your spending as long as you work long enough to build up the accounts. You should try to determine how much you could expect to have at retirement and what the tax brackets would be to decide whether or not you should save some of the money in a regular 401k/IRA to get the tax deductions now at the 25%+ tax rate.

 

[levindb]

You could retire, roll your 401K into multiple IRAs, and use 72(t) rule to take out Substantially Equal Periodic Payments for 5 years from one of those IRAs before age 55, if needed, without penalty.

I would recommend putting max to 401K to get any employer matching and maximum tax reduction in the years before you retire, then use 72(t), noted above, if you need funds before age 55.

 

[DrRoy]

A

 

[newAndImproving]

You could retire, roll your 401K into multiple IRAs, and use 72(t) rule to take out Substantially Equal Periodic Payments for 5 years from one of those IRAs before age 55, if needed, without penalty.

Thanks all!

levindb: The reason to roll the 401k into multiple IRAs is to take SEPP from one, while still maintaining some flexibility / control / ability to contribute to the others?

Is using SEPP a typical plan for FIRE, or is it more common that people have retirement accounts, and then separately some nest egg that they tap until they reach retirement age?

 

[levindb]

Stuff happens...we all know this, but we do not know how much it may change our lives or our budgets. By having an option to begin a 2nd SEPP, you keep from having to get a second mortgage to give you extra spending $$ due to inflation, new kitchen, new roof, new car, etc. I cannot tell you if it is typical. If you do not have a significant after tax account, it is more likely that you will need SEPP or withdrawals from a Roth account.

 

[Sunset]

Thanks all!

levindb: The reason to roll the 401k into multiple IRAs is to take SEPP from one, while still maintaining some flexibility / control / ability to contribute to the others?

Is using SEPP a typical plan for FIRE, or is it more common that people have retirement accounts, and then separately some nest egg that they tap until they reach retirement age?

The SEPP refers to using 72t , which has very specific withdrawal requirements and if you don't take out exactly the right amount each year, the penalties are severe.

It's not common for people to use 72t.

Having multiple IRA's leaves the other ones flexible as to withdrawals.

 

[EvrClrx311]

Though highly ill-advised... you're able to pull money from your retirement account whenever you want. You just face taxes (it'll be treated like normal income for that year) and the potential of a 10% penalty (if it was not Roth) when you do.

As others have indicated, there is a rule 72t that allows for a penalty free way to start pulling funds at a regular interval prior to the age requirements though. Once started, you can't stop, without penalty... so that's also something to plan out appropriately before doing.

 

[simple girl]

Also, if you plan to be on the ACA, and wish to lower your premiums by utilizing subsidies, then you need to have a source of tax-free income to keep your MAGI low until you reach Medicare age. Many utilize taxable accounts (the principle) for this purpose.

 

[mrWinter]

Roth contributions are allowed to be withdrawn without penalty at any time.

Perhaps worth putting greater emphasis on: ROTH contributions can be withdrawn early, not earnings.


So to summarize there are four main options (feel free anyone to add more) for pulling money from retirement accounts prior to 59.5:

• rule of 55 (can withdrawal from company plan if you retire from that same company the year you turn 55 or later)
• withdrawal any Roth contributions, but not earnings
• 72T SEPP (substantially equal periodic payments)
• withdrawal without any of the above and eat a 10% penalty

Possibly worth nothing depending on your age, if you run some numbers you may see that it's possibly better to invest in 401k for a long time and eat the 10% penalty than it is to invest after tax. The two competing values are the capitol gains tax on earnings which you pay in the after tax account vs. 10% tax on entirety of withdrawal. After a long enough period the earnings may be big enough compared to contributions that 10% of total is less than 15% (or more depending on bracket) of earnings. It's also possible that capital gains will be taxed at higher rates in the future (perhaps as normal income), but who knows I guess.

 

[scrabbler1]

Also, if you plan to be on the ACA, and wish to lower your premiums by utilizing subsidies, then you need to have a source of tax-free income to keep your MAGI low until you reach Medicare age. Many utilize taxable accounts (the principle) for this purpose.

Tax-free income is incorrect. I have had a lot of income which was not subject to federal income taxes such as 0% Qualified Dividends and 0% Long-Term Cap Gains and muni bond income. All of it counts toward MAGI which is used to determine ACA subsidies.

If you withdraw principal from any of your after-tax holdings (i.e. cash from your local bank's checking or savings account), that is not part of your MAGI and wouldn't count toward ACA subsidies.

 

[simple girl]

Tax-free income is incorrect. I have had a lot of income which was not subject to federal income taxes such as 0% Qualified Dividends and 0% Long-Term Cap Gains and muni bond income. All of it counts toward MAGI which is used to determine ACA subsidies.

If you withdraw principal from any of your after-tax holdings (i.e. cash from your local bank's checking or savings account), that is not part of your MAGI and wouldn't count toward ACA subsidies.

Oh, yes, I misspoke. You are absolutely correct! I do know this, that is why I said "the principle" from after-tax accounts, but I surely was not clear enough. Thank you for the clarification!

 

[SecondCor521]

Perhaps worth putting greater emphasis on: ROTH contributions can be withdrawn early, not earnings.


So to summarize there are four main options (feel free anyone to add more) for pulling money from retirement accounts prior to 59.5:

• rule of 55 (can withdrawal from company plan if you retire from that same company the year you turn 55 or later)
• withdrawal any Roth contributions, but not earnings
• 72T SEPP (substantially equal periodic payments)
• withdrawal without any of the above and eat a 10% penalty
  [*] Roth conversion ladder - Do Roth conversions and pay ordinary income taxes, leave conversions in the account for five tax years, then withdraw tax- and penalty-free even if before age 59.5

Possibly worth nothing depending on your age, if you run some numbers you may see that it's possibly better to invest in 401k for a long time and eat the 10% penalty than it is to invest after tax. The two competing values are the capitol gains tax on earnings which you pay in the after tax account vs. 10% tax on entirety of withdrawal. After a long enough period the earnings may be big enough compared to contributions that 10% of total is less than 15% (or more depending on bracket) of earnings. It's also possible that capital gains will be taxed at higher rates in the future (perhaps as normal income), but who knows I guess.

Added an option to your list.

 

[Out-to-Lunch]

Perhaps worth putting greater emphasis on: ROTH contributions can be withdrawn early, not earnings.


So to summarize there are four main options (feel free anyone to add more) for pulling money from retirement accounts prior to 59.5:

• rule of 55 (can withdrawal from company plan if you retire from that same company the year you turn 55 or later) or rule of 52 for 457b accounts
• withdrawal any Roth contributions, but not earnings
• 72T SEPP (substantially equal periodic payments)
• withdrawal without any of the above and eat a 10% penalty

Possibly worth nothing depending on your age, if you run some numbers you may see that it's possibly better to invest in 401k for a long time and eat the 10% penalty than it is to invest after tax. The two competing values are the capitol gains tax on earnings which you pay in the after tax account vs. 10% tax on entirety of withdrawal. After a long enough period the earnings may be big enough compared to contributions that 10% of total is less than 15% (or more depending on bracket) of earnings. It's also possible that capital gains will be taxed at higher rates in the future (perhaps as normal income), but who knows I guess.

Added one for admittedly less common 457b accounts.

 

[mrWinter]

Added an option to your list.

• Roth conversion ladder - Do Roth conversions and pay ordinary income taxes, leave conversions in the account for five tax years, then withdraw tax- and penalty-free even if before age 59.5

So if you do a conversion to a ROTH IRA from non-roth accounts, then wait 5 years, that converted money all counts as contributions, even though it may well be substantially composed of earnings from prior to the conversion? Then you are basically withdrawing those 'contributions'? I assume you can't withdrawal earning that accrued during those 5 years? Do I understand that correctly? Nifty little loop hole.

 

[nvestysly]

Lots of options and I'm sure you'll give them all the consideration they're due. DW and I (really just me, but with her knowledge and consent) used the SEPP 72(t) rule and it was very useful. As others have said there are several caveats, but they are all knowable in advance providing you take time to do your research. I have a PDF file with lots of useful information about 72(t). PM if you want a copy. The author of the PDF file has provided me approval to distribute the document to friends.

For online perusal of 72(t) information take a look at the web site below. The web site was instrumental in my 72(t) process.

https://72tnet.com/

 

[SecondCor521]

[/LIST]

So if you do a conversion to a ROTH IRA from non-roth accounts, then wait 5 years, that converted money all counts as contributions, even though it may well be substantially composed of earnings from prior to the conversion? Then you are basically withdrawing those 'contributions'? I assume you can't withdrawal earning that accrued during those 5 years? Do I understand that correctly? Nifty little loop hole.

Sort of, but not exactly.

I always do conversions from my traditional IRA to my Roth IRA. It may be possible to do conversions from other kinds of accounts, but I'm not familiar with those rules. Often you can roll a 401(k) into a traditional IRA first, and then do conversions from there. I think other types of retirement accounts have similar rules.

Roth IRAs always consist of contributions, conversions, and earnings. The first two are based on dollar amounts contributed and converted, and earnings is whatever is left over (and could be negative in theory, but usually is not in practice, especially over long periods of time).

The conversions are not counted as contributions. However, they do come out tax- and penalty-free after they are "seasoned" five tax years inside the Roth.

When you withdraw from a Roth, the IRS always treats withdrawals as coming from contributions first (oldest to most recent), then conversions (oldest to most recent), then earnings. You don't have a choice to withdraw in any other order, however the order that the IRS requires you to use is almost always most beneficial to you.

...

The advantage of this method is that it is more flexible than a 72(t), so for someone doing it for a long period of time like 20 years, it's something you can start, stop, change, and restart as much or as often as you like.

The main drawback is that you usually want to "prime the pump" by having five years of living expenses accessible to live on while your conversions are seasoning inside the Roth, and getting those five years of living expenses saved up outside of IRAs and other retirement plans can be challenging in certain situations.

 

[mrWinter]

Sort of, but not exactly.

I always do conversions from my traditional IRA to my Roth IRA. It may be possible to do conversions from other kinds of accounts, but I'm not familiar with those rules. Often you can roll a 401(k) into a traditional IRA first, and then do conversions from there. I think other types of retirement accounts have similar rules.

Roth IRAs always consist of contributions, conversions, and earnings. The first two are based on dollar amounts contributed and converted, and earnings is whatever is left over (and could be negative in theory, but usually is not in practice, especially over long periods of time).

The conversions are not counted as contributions. However, they do come out tax- and penalty-free after they are "seasoned" five tax years inside the Roth.

When you withdraw from a Roth, the IRS always treats withdrawals as coming from contributions first (oldest to most recent), then conversions (oldest to most recent), then earnings. You don't have a choice to withdraw in any other order, however the order that the IRS requires you to use is almost always most beneficial to you.

...

The advantage of this method is that it is more flexible than a 72(t), so for someone doing it for a long period of time like 20 years, it's something you can start, stop, change, and restart as much or as often as you like.

The main drawback is that you usually want to "prime the pump" by having five years of living expenses accessible to live on while your conversions are seasoning inside the Roth, and getting those five years of living expenses saved up outside of IRAs and other retirement plans can be challenging in certain situations.

Follow-up question: If I put money into a Traditional IRA this year, then immediately (or next year maybe) convert it to a Roth, then all that money is considered conversion and I can withdrawal it and any earnigns on that conversion tax free? Seems like a loophole to effectively get around the rule that only contributions can be withdrawn. Effectively the same form a short term tax standpoint, I pay the same income taxes on the ROTH ammount just delayed a little bit, but all that money is then growing and available to withdrawal tax and penalty free any time.

 

[NgineER]

O-you can only withdraw the contribution tax free after five years. The earnings will keep compounding and be available after 59.5.

 

[SecondCor521]

Follow-up question: If I put money into a Traditional IRA this year, then immediately (or next year maybe) convert it to a Roth, then all that money is considered conversion and I can withdrawal it and any earnigns on that conversion tax free? Seems like a loophole to effectively get around the rule that only contributions can be withdrawn. Effectively the same form a short term tax standpoint, I pay the same income taxes on the ROTH amount just delayed a little bit, but all that money is then growing and available to withdrawal tax and penalty free any time.

NgineER has it right, but I'll answer as well.

There are two things wrong with your understanding:

1. You must leave any conversions in for 5 tax years before they can be withdrawn tax- and penalty-free. Re-read what I wrote about "seasoning".

2. Whenever you make a withdrawal from a Roth IRA, the IRS requires you to follow a certain order. You *must* withdraw your money in the following order: all contributions first, then all conversions second, then all earnings last.

Regarding this second point, it completely does not matter what you bought or sold within the IRA at all. You can't, for example, make a contribution of $5K in year 1 and buy stock A, then make a contribution of $4K in year 2 and buy stock B, then in year 3 sell $4K of stock B, receive a dividend of $100 and withdraw $4,100 and treat that as being from your contribution from year 2 and the earnings. The IRS treates the IRA as a complete black box and applies ordering rules. They would treat the $4,100 as being part your $5K contribution from year 1 (because it's your first contribution). You would then have $900 of year 1 contributions left, then $4K from year 2, then $100 of earnings, in that order.

 

[armor99]

Perhaps worth putting greater emphasis on: ROTH contributions can be withdrawn early, not earnings.


So to summarize there are four main options (feel free anyone to add more) for pulling money from retirement accounts prior to 59.5:

• rule of 55 (can withdrawal from company plan if you retire from that same company the year you turn 55 or later)
• withdrawal any Roth contributions, but not earnings
• 72T SEPP (substantially equal periodic payments)
• withdrawal without any of the above and eat a 10% penalty

Possibly worth nothing depending on your age, if you run some numbers you may see that it's possibly better to invest in 401k for a long time and eat the 10% penalty than it is to invest after tax. The two competing values are the capitol gains tax on earnings which you pay in the after tax account vs. 10% tax on entirety of withdrawal. After a long enough period the earnings may be big enough compared to contributions that 10% of total is less than 15% (or more depending on bracket) of earnings. It's also possible that capital gains will be taxed at higher rates in the future (perhaps as normal income), but who knows I guess.

Just one issue some people might find themselves in... like I do.

If you have a ROTH 401k. When you turn 55 (assuming you are retiring then) you must first roll over your ROTH 401k to a ROTH IRA, before you attempt to withdraw your personal contributions.
From a ROTH 401k (rule of 55), you will get taxed some amount on the growth. They will not let you just take out your own personal contributions. Once that money gets to a ROTH IRA, you can take out just your personal contributions first with no tax or penalties at all.
Provided you have enough personal contributions to make it to 59.5, at that time the entire ROTH IRA is tax and penalty free.

This is what I am intending to do... [emoji3]