Deciding When to Retire – How to Access Retirement Funds Penalty Free


Deciding when to retire can be a difficult decision to make.  Will I have enough income from my retirement accounts, pension, and social security to live comfortably in retirement?  A common misunderstanding of individuals contemplating when to retire is that you can not access your retirement accounts or any personal pension schemes until you are at least age 59 1/2.  You may be surprised to learn that there are ways to withdraw funds from your retirement accounts before age 59 1/2 and avoid paying the 10% early withdrawal penalty.

Ways to Retire Early and Avoid Early Withdrawal Penalty

Substantially Equal Periodic Payments – By taking distributions from your IRA that are substantially equal payments over your expected lifespan or the combined lifespans of you and a designated beneficiary you can avoid the 10% early withdrawal fee.  Use an IRS-approved distribution method and take the exact same distribution each year.  You don’t have to take distributions based upon the entire balance in your IRA so “splitting” the account and taking distributions from only one of them is an option.

Leaving a Job After Age 55 – If you are at least 55 when you leave your job, you will not have to pay the 10% early withdrawal fee on any distribution you receive from your former employer’s retirement plan. You only need to turn 55 by December 31st of the same year you separated from your employer to qualify for the age 55 exception.  You also can go back to work for another company or even go back to work for the same company at a later date.  This exception does not apply to IRAs.

Other Ways to Access Retirement Income Penalty Free

Withdrawing money from a retirement account is never a good idea since you will lose out on potential asset appreciation and the benefits of compounding returns.  There are however life events that may make accessing your retirement accounts necessary, these are some of the ways you can access your retirement accounts and avoid the early withdrawal penalty.

Higher Education Costs – Withdrawals for qualified education costs for yourself, your spouse, or the children or grandchildren of you or your spouse are not subject to the 10% penalty. Qualified education expenses include: tuition, books, supplies, fees, equipment, and room and board for a student who is attending college at least half-time.  Keep in mind that IRA withdrawals are considered income and will effect your child’s eligibility for financial aid.

A First Home – You may take a distribution from your IRA penalty-free for the purchase of your first home but there are some restrictions:

  • The exemption has a lifetime limitation of $10,000
  • Distributed funds must be used to purchase a principle residence for a first-time homeowner.  A married home buyer or their spouse my not have had an ownership interest in any principle residence in the last two years.
  • Distributed funds must be used to purchase a principle residence within the first 120 days after receiving distribution.
  • The first-time homeowner must be the owner of the IRA, the owner’s spouse, or a child, an ancestor, or a grandchild of the owner or the owner’s spouse.

Military Service – Military Reservists who were called to active-duty after September 11, 2001, for a period of more than 179 days, may take early distribution from an IRA penalty free.  The distribution must be made during the active duty period and is available to Military Reservists in the following branches: Army, Navy, Air Force, Marines, and Coast Guard Reserves.

An Inherited IRA – If you are the beneficiary of the IRA of a deceased owner, then you may take the entire distribution penalty free.

Dividends From an ESOP – An ESOP, or employee stock ownership plan, allows for cash distributions as long as the employee has a right to demand that benefits be paid in employer stock.  Dividends from stock held in an employee’s ESOP are not subject to the early distribution penalty regardless of age.

Medical Expenses – Withdrawals from your retirement plan for medical expenses for yourself, spouse, or dependent are exempt from the early withdrawal penalty only for the portion of medical expenses that exceed 7.5% of your gross income.  You can take advantage of this exclusion even if you do not itemize.

Health Insurance Premiums – If you lose your job and collect unemployment for at least 12 consecutive weeks, you can use distributions from an IRA to pay for health insurance premiums for yourself, a spouse, or dependents, penalty free.  To be eligible for the exemption, the distribution must have occurred in the year or year after you received the unemployment compensation and no later than 60 days after you have gone back to work.

QDRO Payments – Payments for child support or alimony from a retirement plan are not subject to the early withdrawal penalty if they are required under a QDRO, Qualified Domestic Relations Order.  This exception does not apply to IRAs.

Deciding when to retire takes planning and a great resource to start with is the AARP Retirement Planner.

Under what circumstances would you withdraw funds from a retirement account?  What about in the case of early retirement?

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25 Responses to Deciding When to Retire – How to Access Retirement Funds Penalty Free

  1. krantcents 12/26/2011 at 3:40 pm #

    When I retired (first time), I did not withdraw any IRA funds. I made sure I had sufficient cash flow to avoid that. When I retire soon (5.5 years) I will have the funds to support my lifestyle.

    • Paul 12/27/2011 at 12:07 am #

      I’m jealous KC! You will have retired twice before I reach my first retirement..

  2. YFS 12/26/2011 at 8:31 pm #

    Funny that you mention this.. I’m not a fan of 529 plans so my goal is to invest as much as I can into my 401k.. and traditional IRA. By time my future child is of school age I would have certain left my employer and of course rolled the money into the traditional IRA. I will use the education cost exclusion to pay for my child’s tuition if he/she has one. If my child gets a scholarship.. great I have a huge retirement account anyway. This is much better than a 529 in my eyes.

  3. Amanda L Grossman 12/27/2011 at 6:52 am #

    Great topic–I haven’t seen it covered before.

    I have not figured out the age that I would like to retire, nor have I talked about it to my husband. But it would be interesting for us to do some projections. I guess I would always be concerned that we would retire without enough if we withdrew early. Also, I tend to be a workaholic…so I might just retire and start a new career!

    • Paul 12/27/2011 at 9:00 am #

      I’m with you Amanda in that I don’t believe in touching any retirement fund until retirement. Having said that there are emergencies like losing a job and the ability to pay for health insurance where I could see the need to access funds on a short-term basis. The option is there if you need it and it is most likely a better option than taking on high interest debt. You can always replace the funds.

  4. Financial Samurai 12/31/2011 at 10:10 pm #

    Interesting on the 55 year old exception!

    What about if you retire at 40, return at 53, retire at 55. Still no penalty? Or has to be continuous?

    thx

    • Paul 01/01/2012 at 12:44 am #

      I’m assuming you rolled over your non-ira qualified retirement funds prior to age 55? If so, you may take distribution without the 10% early withdrawal penalty. You may use the 55 year old exception only once however, so if you did not pay the 10% penalty and took distribution prior to 55 you can’t use the 55 exception again.

  5. Buck Inspire 01/01/2012 at 5:00 am #

    If you use your funds for a first time home purchase, can you explain $10,000 lifetime limitation exemption? Thanks and Happy New Year!

  6. Evan 01/04/2012 at 10:22 pm #

    It sort of falls under 72t distributions – but a SPIA may be a cool option for many

  7. Barb Friedberg 01/13/2012 at 5:57 pm #

    Fortunately, I’m not looking to retire early. I love my work and my lifestyle and I hope to live a really long life. Plus, we take some nice vacations and enjoy ourselves in the present. It’s a bad idea to put off living until retirement!

  8. GKS 02/01/2014 at 4:55 pm #

    Yes 55 year old exception helped me as my company forced me to retire last month, as 2013 was the year I was fully vested for retirement based on age and years with the company (25).

    So 20% taxes held immediately but no penalty; will have to use the money to pay off debt-maybe some will be left to pay some mortgage payments until I can hopefully find a job.

    Not easy to find a job at 58 years of age though and I will take atleast a 50%+ cut in pay as I was 6 figure with a bonus every year…

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