Although retiring early, let alone before the penalty-free distribution age of 59 ½, seems like an impossible dream for some, it is entirely possible with proper planning. An issue with retiring before 59 ½ comes from the 10% penalty for early withdrawals. As the average person doesn’t want to lose their hard-earned money, this can turn people away from retiring before 59 ½. Some options to get around this penalty include using a Bridge Account, the Rule of 72(t), and the Rule of 55, which I will discuss and explain in this article.
Bridge (Brokerage) Account
If you want to retire early, a bridge account could work for you. A bridge account is a nickname for a brokerage account that is used to “bridge the gap” from retirement to age 59 ½, where you can begin taking withdrawals from IRAs and employer-sponsored plans penalty-free. One disadvantage of a bridge account is that it does not have the tax advantages of a retirement account, so taxes will need to be paid on all growth, dividends, and realized gains on a yearly basis.
One advantage of a bridge account is that the money can be withdrawn anytime. If an emergency were to take place that your emergency fund could not cover, then you could take funds from the bridge account. In this aspect, it can double as a retirement fund or an extra emergency fund. A bridge account offers much more flexibility than a traditional retirement account but does not offer the same tax advantages.
Rule of 72(t)
The Rule of 72(t) is issued by the IRS. It allows for penalty-free withdrawals before 59 ½. There must be at least five withdrawals over a substantially equal periodic payment (SEPP) or until you reach 59 ½, whichever comes later. The amount of the withdrawals is calculated using one of three IRS-approved methods: the amortization method, the minimum distribution (also known as the life expectancy method), or the annuitization method. The Rule of 72(t) should be seen as a last resort, as it can put your financial future at risk, as it essentially sets your distributions in place with no ability to change for the period of five years or until age 59 ½.
Rule of 55
The Rule of 55 only applies to 401(k)s and has many associated rules. The first rule is that you must leave your job in the calendar year you turn 55 or later. This means you cannot leave at 54 or earlier and expect to get distributions when you turn 55. However, there are specific jobs where the rule starts at 50. This mainly applies to public safety employees, such as police officers, firefighters, etc. Another rule is that you cannot draw from another retirement account, so you cannot apply the Rule of 72(t) to draw from another account.
However, since a bridge account is not a retirement account, you could draw from that account. This could be useful if you want to retire before 55. Another rule is that the funds must stay in the employer’s 401(k) while you’re taking distributions. This means that you cannot perform a rollover and withdraw funds penalty-free. One interesting rule is that you can get another job and still withdraw funds penalty-free. Something to consider when using this rule is the possibility that the 401(k) custodian moves the funds into an IRA on their own, which would mean you would begin being penalized for distributions.
Which Option Is Best For You If Retiring Before 59 ½?
Everyone’s situation is unique, so no ‘one-size-fits-all’ option exists. If you are interested in seeing which option is best for you, one of our financial advisors at Whitaker-Myers Wealth Managers would be happy to help you explore your options. Schedule an initial meeting to discuss the different scenarios and determine which is best for you.
Options for Retiring Before 59 ½
September 3, 2024
David Gearhart
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