Can you retire before the age of 59.5? The quick answer is maybe, but many mistakenly believe that they simply cannot leave their job and access the retirement accounts before this age. In fact, while the IRS has a general rule that imposes a 10% penalty on accessing your retirement accounts before 59.5, there are many exceptions that allow those with adequate savings to retire in their 50’s. When I work with retirees that have not yet reached that age of 59.5, I like to develop a plan to take advantage of these exceptions. Often, it is best to use more than one strategy to provide optimal income and flexibility. Here is a quick overview of the most common tools we use, and the way we approach a plan to retire in your 50’s.
1. Cash Savings
Ok. I admit that cash savings do not qualify as ‘retirement accounts’, but saving money outside of and in addition to your 401k or IRA savings is a good way to build flexibility and freedom. You can simply add money to your bank account, or open a brokerage account. While these types of accounts do not enjoy the tax advantages of a 401k or IRA, they also do not have the restrictions and can be accessed at any time.
2.The Age 55 Rule
An often overlooked rule in the Tax Code is what we call the “Age 55 Rule”. This exception allows you to take money out of your 401k without penalty if you are 55 years old or older when you retire. The IRS rule is fairly straightforward, but here are a few important considerations. First, the exception applies only to 401k’s, not IRA’s, so you must take the distribution directly from your 401k before rolling it over to an IRA. Secondly, the rule requires you to be 55 years old or older in the year in which you retire. This means that you cannot retire at 54 and then begin taking distributions from your 401k at age 55. Finally, your company may put additional restrictions on distributions beyond the IRS rules. For example, many companies will now require employees to take a 100% distribution when distributing from a 401k, which means you only get one chance to use the Age 55 Rule. You can still roll over the majority of your 401k, taking a taxable distribution for only what you need, but these types of company restrictions can limit your ability to bridge multiple years using the Age 55 Rule.
3. The Substantially Equal Payment Plan
We have written in the past about the Substantially Equal Payment Plan or SEPP. Sometimes called a 72(t) for the Tax Code section that authorizes this exception, the SEPP provides for penalty-free pre 59.5 distributions from an IRA when equal annual payments are made for the longer of 5 years or until the age of 59.5. Essentially, the IRS is saying “you can access your retirement accounts without penalty, but only if you are really retiring.” Unlike the Age 55 exception, the SEPP exception is very complex, and the penalties for error are significant, so I highly recommend you get help from a professional advisor before starting a SEPP. Nonetheless, they can be an effective tool to bridge a retiree to age 59.5
4. Executive Compensation
In addition to more common 401k or IRA savings accounts, some executives are also eligible to participate in deferred compensation plans or stock option plans that can provide income before age 59.5. For example, a 457 plan is a type of deferred compensation plan that, while designed for retirement, can be accessed without penalty before age 59.5. Similarly, stock option plans often require retirees to sell vested options upon retirement. While these plans are both taxable, they do not have the 10% penalty for distribution before age 59.5 like many other retirement vehicles. Not everyone has these types of plans, and there are several different types of plans. If you are not sure if you are eligible, and what type of plan is available, ask your human resources department.
5. Putting it all together
Once you have researched all the options, you can use each of these exceptions to prepare a pre-59.5 that will provide the income you need for retirement. Often, the best plan does not use just one exception but uses several at the right time to achieve the best income and tax result. It is hard to retire in your 50’s, but mostly because it requires significant savings to provide income for the rest of your life. The tax rules surrounding age 59.5 should not prevent you from retiring when you want. Admittedly, the rules can be complex, but most retirees can retire in their 50’s without incurring the 10% penalty. Most importantly, with the right planning, you can achieve the goal of retiring early.