Financing Early Retirement
If you're planning on retiring early, having 'enough' money is only half of the battle: the money must be accessible for withdrawal in the amounts and at the times you need it.
An important part of retirement planning is ensuring that your financial pipeline is full—that you will always have sufficient withdrawal capacity to cover your expenses, plus a margin of safety.
The American retirement system is built to support retirement around the ages of 60 to 70. With a little planning and a lot of saving, the system can be adapted to support retirement ages in the 30's and 40's.
For the purpose of these demos, we will assume a reasonable after-tax investment return of 5%.
The Taxable Account
This money is fair game at any time. Start your withdrawals here, but do your best to stay in a low tax bracket!
Earnings in an IRA become available at age 59.5.
Roth IRA Principal
Principal in a Roth IRA is available for withdrawal at any time and for any reason. The principal that may be stored in a Roth IRA is fairly limited, however: at current contribution limits, one could only amass $55,000 in principal after working for 10 years.
One way to improve this? Get married! Even if your spouse does not work, they may contribute to a spousal IRA. Working together, you can double the principal you can amass in 10 years to $110,000. If you can shrink your budget to $27,500 per year, that will cover 4 years of expenses!
IRS Rule 72t for Traditional IRAs
You've done it! You've successfully saved whatever your target is for early retirement—$1MM, $2MM... or maybe just $50k if you're ERE's Jacob. A lot of that money is likely locked up inside retirement accounts. How do you bust it out?
FIRST, keep in mind that those retirement accounts provide a tax advantage. That's why you put the money in there in the first place! Always keep your overall goal in mind: maximizing the value and utility of whatever money is available to you. A great way to do that is by minimizing the taxes that you pay over your lifetime. That tax-deferred growth is really nice to have, so optimally you'd like to delay taking money out of tax-deferred accounts for as long as possible.
If you're under age 59.5 and you're not totally disabled, early withdrawals from retirement accounts will normally be taxed as income and slapped with a 10% early distribution penalty. But United States Internal Revenue Code §72(t)(1) contains an exception—you can withdraw substantially equal periodic payments ('SEPP', not to be confused with 'SEP' = Simplified Employee Pension) from one or more IRAs without paying the penalty!
Be forewarned that if you START taking SEPP, you can't STOP until you reach age 59.5 AND a minimum of five years of payments have occurred.
How big are these payments? You can't just take out any amount—the IRS allows three different methods of calculating the annual payment size, though all three methods yield similar-ish results. Bankrate has a 72(t) distribution calculator that will give you an idea of what the payments will look like, though a 3% annual withdrawal rate ($3,000 for every $100,000 in the account) is pretty typical for an early retiree. As Mr. Money Mustache points out, at $250 per month from a $100,000 account, that'll at least cover your groceries!
You can roll over your employer-sponsored 401(k), 403(b), or 457(b) plan into an IRA and use SEPP to withdraw money. SEPP is handled individually for each IRA, so you can determine your desired SEPP withdrawal rate and roll money between IRAs to adjust the balance to meet your target!
You must manually claim an exception from the 10% penalty tax by filing IRS Form 5329.
- SEPP @ Vanguard
- SEPP @ Bogleheads Investor Wiki
- SEPP FAQ @ IRS.gov
- SEPP @ Wikipedia
- SEPP @ Investopedia
- SEPP @ Moneycrashers
- "How Much is Too Much in your 401(k)?" @ Mr. Money Mustache
- 72t.net - links to calculators, current interest rates, &etc
- 26 USC §72, the legal basis for SEPP
Principal and earnings in a 401(k) become available at age 59.5.
Working for 10 years at current contribution limits, one could amass $175,000 in principal.
If you were born in 1960 or later, your full retirement age is 67. You can begin receiving benefits as early as 62, but you'll receive 25% less to compensate. If you delay retirement to age 70, you'll receive 24% extra!