There is one account that we need to make sure clients have if they’re thinking about retiring before age 60, and that’s because there’s a 10% penalty for withdrawals from IRAs and 401ks if you’re under that magic age of 59 and a half. There are exceptions to that penalty, and it allows people to take money out without paying the 10% penalty. Some of the exceptions apply only to IRAs and some apply only to 401k’s, so it’s important to know the rules for both of those before you actually retire and start implementing that income plan that you planned for.
Let’s go over the exception so you don’t get stuck paying that extra 10% penalty to the government if you’re retiring before age 60. Just as a reminder, before making any decisions with finances, always be sure to just talk to your financial professionals so that you make sure you’re not missing anything when implementing these things.
The first exception for IRAs only is buying health insurance if you lost your job and you collect unemployment for at least 12 consecutive weeks. The next exception is paying for higher education expenses either for yourself or for your kids. It also works for grandkids as well. The third probably doesn’t apply to you, but it’s that it’s up to you to withdraw up to 10,000 from your IRAs for a down payment on the first time purchase of a house. So, first time home buyers purchase.
Next is the exception to the 10% penalty for 401ks. And similar plans like 403Bs or a few other qualified retirement plans. So, this is just 401ks and those types, not IRAs. Now, there are about five or so exceptions here, but there’s really one that really matters, and it may be applicable to you and your retirement plan. I’ll share it, and then I’ll share a mistake that sometimes people make when they’re planning retirement, and that most applicable one is the rule of 55. The rule of 55 is an IRA’s guideline that allows you to avoid paying the 10% penalty or early withdrawal penalty on 401ks and 403b retirement accounts.
If you leave your job during or after the calendar year you turn 55, the rule applies regardless of the terms of your separation. You can either take advantage of it whether you have been laid off or if you decide to just retire early. The rules with this exception are very specific. I’ve seen some plans in the past where they actually don’t have this built in this age 55 to 60, which are without penalty, but you just want to make sure that it’s there, and that you can take advantage of it.
The mistake I see people make when they’re planning their retirement: they map out their retirement at age 55, and everything looks good and they have enough in the non-retirement accounts that are not subject to withdrawal tax when they take money out. They’ll use that for the first five years. So, maybe their brokerage account, cash, the bank, things like that because they’ve got five years outside of retirement accounts, they’ll roll over their entire 401k or their 403b to an IRA. The problem that we sometimes see happen is if something doesn’t go according to plan, they may find themselves having to draw from their IRA earlier than planned (earlier than age 59 and a half or 60), and because it’s not in that 401k anymore, they would have to pay the 10% penalty to take it out of their IRA.
It might be worth not rolling over the 100% of your 401k to an IRA if you’re under 59 and a half, and maybe have that little buffer in there as the second line of defense or or backup plan in your 401k if you needed something else. Now, there are a few other exceptions to the 401k 10% penalty that apply to a few select people like public safety employees and government 457 plans. Here’s an article to learn more.
Up next are a few of the exceptions that could apply to the IRA or 401k. So, here are some of the other exceptions to IRA or 401k or 403b: medical expenses to the extent that they exceed 10% of your adjusted gross income. The next one comes with a warning and it’s the exception which is substantially equal payments. That’s also known as the 72T exception. This is where you take your balance distributions over substantially equal payments. It sounds confusing, but being part of a CPA firm that helps over 2,000 people, I’ve seen quite a few times where this strategy goes wrong; if it’s done wrong the entire balance of the account could be taxable including that 10% penalty if you’re under 59 and a half. Hence the warning if you’re looking at this one.
Just make sure you’ve got a CPA or your team evaluating all the things to make sure that it’s done right. The next exception is disability, and it must meet the IRA’s definition of total permanent disability, and you’ve got to have documentation from a doctor. The next one is adoptions or the birth of a child up to 5,000 in withdrawals can be penalty free in that first year for the adoption year. There are a few more exceptions, but these are the ones that seem to be the most common. To see all of them, read this article.
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Disclosures: Securities offered through LaSalle St. Securities LLC (LSS), member FINRA/SIPC. Advisory services offered through LaSalle St. Investment Advisors LLC (LSIA), a Registered Investment Advisor. Streamline Financial Services is not affiliated with LSS or LSIA. LSS is affiliated with LSIA.