It’s no wonder that 401k plans catch a lot of criticism from employees.
In the old days when you had a pension, it was always clearly defined when you’d be able to retire and exactly how much money you stood to make from the deal. Not a lot of thinking or strategy was involved.
Though most people don’t realize it, those times have changed – and for the better! Now all you have to do is reach the 401k retirement age, make sure you’ve got enough money saved up, and then start to cash you when you feel you’re ready.
When Exactly is the 401k Retirement Age?
The IRS 401k withdrawal rules state that none of us can actually dip into retirement plans until the age 59-1/2. For whatever reason 59-1/2 is officially the age at which the government declares you ready to access your money.
If you try to touch your money prior to that, you’ll unfortunately find yourself slapped with a 10% penalty on top of taxes for whatever amount you withdrew. That’s definitely something that you don’t want to do because it would diminish the earnings you waited so long to achieve.
Now whether or not you’ve got enough money saved up by the 401k retirement age is entirely up to you. Compared to your peers you could probably easily beat the average retirement savings of other individuals your age.
But that’s not going to give you the whole picture. You’ll need to figure out how much YOU actually need. The easy way to do that is to take the amount of money you’ll need in one year and multiply it times 25. So for example if you think you’ll need $50,000 each year to live on, then you should try to target saving $50,000 x 25 = $1,125,000.
Why multiply it by 25? Because that’s the same thing as dividing by 4% (in other words 1/0.04 = 25). 4% is the popular figure financial planners when they are figuring out how much money you can safely withdraw during retirement.
What If I Want to Retire Sooner?
If you are ambitious and simply can’t wait until the full 401k retirement age to declare your official retirement, there are fortunately a few smart retirement income strategies that you can use to get access to your money sooner rather than later:
Leave Work at Age 55. If it’s only 4 years or so you’re looking to gain for retirement, the IRS does make a special exception where if you can take a penalty free 401k withdraw if you leave your job at age 55 or later:
Exceptions. The 10% tax will not apply if distributions before age 59½ are made in any of the following circumstances: Made to a participant after separation from service if the separation occurred during or after the calendar year in which the participant reached age 55.
But what if you’re looking to retire a whole lot sooner than that? Say at age 50? Or even age 40?? There is another little known loop-hole for you as well.
Use a SEPP. An SEPP (series of equal periodic payments) or 72t distribution is a little known trick in the IRS tax laws that allows you to withdraw a small portion of your savings each year without penalty.
To use a SEPP, all you need to do is move your savings over to a rollover IRA. Make sure to check with both your old and new financial institutions to be sure that there aren’t any big fees or costs involved with the transition. Once the transfer is complete you can start making withdraws based on one of three calculated methods provided by the IRS.
However, proceed with caution using this strategy since it can be a little bit tricky. Report it wrong to the IRS, and you might end up sabotaging your efforts and paying that 10% penalty after all! You may want to seek the help of an accountant to make sure you’re doing this one right.
Use a Roth IRA. If you can manage to save portion of your savings in a Roth IRA, then not only will you not pay taxes on your future withdraws but you’ll also be able to withdraw your principal investment whenever you want to (as long as it’s been in there for more than 5 years). You unfortunately though will not be able to withdraw the earnings until after age 59-1/2.
Regular brokerage account. The final thing you could do to get access to money sooner than the 401k retirement age is to invest some of your money in a regular brokerage account; preferably in blue-chip dividend paying stocks. Although the tax benefits won’t be as great, you’ll be allow to access your money anytime you feel like it without repercussions or penalties from the IRS.
Are you looking to retire early and need to access the funds in your 401k prior to 59 1/2? Does your employer offer retirement plans? What other methods are you using to grow your wealth for your retirement years?
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