As I mentioned in a recent blog post, more than half of U.S. adults aged 55 and above are now retired. Obviously that figure includes seniors in the more traditional age range of 65-70 years old. But what about folks at the lower end of that statistic?
Some of these retirements might be temporary responses to pandemic safety concerns, burnout, or a transition to a new career. Others will be full early retirements for folks who want to get a jump start on their not-quite Golden Years.
Whatever the plan may be, retirement before age 59 1/2 can pose some significant cash flow challenges for folks who need early access to their IRAs and 401(k)s. On today's show, we discuss how incorporating IRS code 72(t) into a financial plan can help.
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1. Penalty-free early withdrawals.
In most cases, taking withdrawals from your retirement accounts before age 59 1/2 triggers a 10% penalty in addition to ordinary income tax in your respective bracket. Code 72(t) allows for early withdrawals without that penalty, subject to a few rules.
Your withdrawal amount is calculated using a formula that takes into account current interest rates and the government's life expectancy tables. You then have to make substantially equal withdrawals annually for the longer of five years or until you reach age 59 1/2. So, someone who starts taking 72(t) withdrawals at age 58 would have to keep making those withdrawals until age 63.
2. Too much too soon?
Because interest rates have been so low, as of January 2022, the federal government now allows you to use the greater of 5% or 120% of the mid-term interest rate when making these 72(t) calculations. That's good for the growing number of early retirees.
But I do worry that folks might start taking out too much too soon. Remember, these accounts are really meant to keep growing so that they can provide security into a retiree’s 70s, 80s, and beyond.
As a back-of-the-napkin example, let's consider a 50-year-old early retiree with $1 million in an IRA. With the new interest rate floor, this individual could withdraw $61,600 per year from that IRA. And, under rule 72(t), she would have to keep making that annual withdrawal for nine and a half years. That's a sizable dent to a nest egg, especially when you consider this person might also be paying higher costs for health insurance until she's eligible for Medicare at age 65. And that's not even considering all the compound growth and income that she's going to be missing out on due to those withdrawals.
3. All part of the plan.
It's important that you assess all your options and your long-term financial goals before you decide to take 72(t) distributions. There certainly are instances where penalty-free early withdrawals are a good choice, particularly in emergency or forced early retirement scenarios. There are even strategies for designating a separate IRA account for the 72(t) withdrawals while maintaining additional IRA’s as non 72(t) to provide flexibility for future withdrawals.
Moreover, none of these decisions exists in a vacuum. COVID may have accelerated or altered retirement plans for many people, but optimizing those plans is an ongoing process. My own book, Keen on Retirement: Engineering The Second Half Of Your Life, will need some freshening up if Congress passes an update to the SECURE Act and starts rolling back the ages at which seniors have to take required minimum distributions.
One of the biggest advantages of working with my team at Keen Wealth is that we keep close tabs on these rule changes and then adapt our individualized planning process accordingly. Give us a call and let's talk about how your early withdrawal options fit into your long-term thinking about life, work, legacy, and an ideal retirement.
Bill Keen is a CHARTERED RETIREMENT PLANNING COUNSELOR℠ and independent financial advisor with more than 25 years of industry experience. As the founder and CEO of Keen Wealth Advisors, a registered investment advisory firm, he specializes in providing personalized retirement planning designed to help people thrive before and during their retirement years. With a passion for educating others, Bill regularly blogs about retirement planning, hosts the podcast Keen on Retirement, and has contributed to U.S. News and World Report, Reuters, Wall Street Journal’s Market Watch, Yahoo Finance, and other publications. Based in Overland Park, Kansas, Bill and his team work with clients throughout the greater Kansas City area and across the nation. To learn more, connect with him on LinkedIn or visit www.keenwealthadvisors.com.
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