Imagine you have been a diligent investor, and you have saved to your retirement accounts for years, amassing an impressive total. You are proud of what you have accomplished, but here you are, younger than age 59 ½ and you are out of work. Perhaps your company was sold and your job eliminated, or you want to work part-time. Maybe you just want to retire early. The only “problem” is your wealth is in tax-deferred retirement accounts.
Usually any withdrawal from a tax-deferred retirement account before age 59 ½ comes with a 10% early withdrawal penalty. While the IRS has provided for several circumstances that are not subject to the penalty, such as a qualifying disability, medical expenses, higher education expenses or first time homebuyer, your situation doesn’t meet any of these exceptions.
The good news is you are in luck. The IRS allows qualified retirement plan owners to take substantially equal periodic payments for the longer of five years or until you reach age 59 ½. This allowed method is complicated and comes with caveats, notably the fact you cannot decide how much you want to withdraw. You must calculate your allowed withdrawal using one of three IRS-approved methods: the RMD method, which calculates the withdrawal each year based on the account balance, or the fixed amortization method or the fixed annuitization method, both of which calculate the withdrawal using an interest rate and IRS mortality tables to determine your life expectancy.
Providing a bit more flexibility, you do not have to aggregate your retirement accounts. You can calculate your substantially equal periodic payment based on a single account, which gives you more control of the distribution amount. Because these withdrawals are coming from qualified tax-deferred accounts, the payments to you are subject to normal income tax. This method only eliminates the 10% early withdrawal penalty. Of course, depending on the balance in your accounts, these payments could greatly affect your tax situation.
As mentioned before, deciding to take substantially equal periodic payments is a commitment for at least five years or until you attain age 59 ½, whichever is longer. Furthermore, if you modify the payments by taking more or less than you should have, you generally will be subject to the 10% premature distribution penalty on the taxable part of all payments made to you before you reached age 59 ½. Any errors in calculations can make this withdrawal strategy a very bad idea, so it is imperative to enlist the help of a qualified financial adviser and tax consultant. Once you meet the required period of payments, you can change how much you withdraw or stop withdrawals altogether.
If you are 56, this can be a viable option if you want to retire early; however, if you are 50, the nine and a half years of required payments could deplete your retirement savings earlier than you want. While this may not be detrimental to your retirement savings initially, it can certainly create a shortage later in life should you exceed your life expectancy. A substantial amount of planning is needed.
If you have questions on whether using substantially equal periodic payments is a feasible withdrawal method for you, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166.
Disclosures: This article is meant to provide valuable background information on particular investments, NOT a recommendation to buy. The investments referenced within this article may currently be traded by Henssler Financial. All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing. Henssler is not licensed to offer or sell insurance products, and this overview is not to be construed as an offer to purchase any insurance products.
