How To Access Retirement Dollars Early Without Paying Penalties

In this episode of Friends Talk Financial Planning, we discuss ways to access retirement funds before the usual age of 59½ without paying the standard 10% early withdrawal penalty. Many people assume they’re completely locked out of their retirement accounts until that age, but there are several exceptions worth knowing. One key option is the “age 55 rule,” which allows individuals to take money from a 401(k) or 403(b) plan without penalty if you leave our job at age 55 or older. It’s important to remember this only applies to the retirement plan at the current employer and doesn’t extend to IRAs—rolling funds into an IRA would eliminate this opportunity.

We also discuss 457 plans, which are common for government and non-profit workers. These plans don’t impose a penalty for early withdrawals at all, regardless of age, making them extremely flexible. Another option is Rule 72(t), or Substantially Equal Periodic Payments (SEPP). With this method, individuals can start drawing from our retirement accounts at any age, as long as they commit to taking equal payments for at least five years or until we turn 59½. While useful, this strategy is complicated and best approached with professional help.

Beyond these, there are also several exceptions to the 10% penalty to consider. For example, if you are using the money for qualifying medical expenses, you may be able to avoid some or all of the penalty. Even if a withdrawal doesn’t qualify for an exception, it might still make sense in certain low-income years. If you contributed to our retirement accounts in a high tax bracket and now face much lower taxes—even after the penalty—the net effect might still be favorable. Ultimately, these strategies show the importance of good tax planning, and we recommend working with a CPA or financial advisor to determine the best path forward.

Resources:

- Alliance of Comprehensive Planners: https://www.acplanners.org

- John's firm website: https://www.trinfin.com

-Find us on Facebook: www.facebook.com/friendstalkfinancialplanning

#ACPMemberWisdom #financialplanning #retirement #retirementplanning 

TRANSCRIPT:

John: Bridget, most people think that they have to leave their money in their retirement plans until age 59 and a half before they can take it out. But on today's episode of Friends Talk Financial Planning, we're going to talk about ways that you can access that money before age 59 and a half that not many people know about. Hi, I'm John Scherer, and I run a fee-only financial planning practice in Middleton, Wisconsin.

Bridget: And I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. Before we talk about getting money out of your IRA before you're 59, let's have you subscribe. It helps us get credibility with YouTube. All right, John, let's talk. We have somebody, let's say they're 50. Okay, so I'm 50. I need some money from my retirement accounts. How do you proceed?

John: Yeah. I was having a conversation with a friend of mine a while back, and he's a couple years older than 50, but he said, “Oh, I got seven years left and then I can retire.” And I said, “Oh, really? Why is that?” “Well, that's when I can access my money. Then I'll be 60 years old, so I'll be over the limit where I can get to my retirement plan, my 401(k).” And I go, “Oh, interesting.” And again, that generally is the rule. That's sort of the blanket thing.

And what happens if I take money out of my retirement plan to spend it before I'm 59 and a half, in general, there's a 10% penalty that goes along with that. And so that's the incentive. And sometimes people don't even know that. Hey, wait a minute, know that rule. But then there are some exceptions and some ways that you can access that, so it's not just locked away until that age.

And the one that is the big one for me, and it was for this friend of mine that I was talking with, is if you retire from your employer at age 55 or later, then the money that's in that retirement plan isn't subject to the 10% penalty anymore. It's basically an age 55 rule from the current employer's retirement plan, 403(b) or 401(k) sort of thing. So many people haven't even heard that. And that's really important information to know about.

Bridget: Right. Because that takes us from 59 to 55.

John: Right.

Bridget: But there're ways even if you're 55 or younger to get it out. Why don't we talk through that?

John: Sure. And before we jump over into those, I just want to point out something for the age 55 one for a second. It's only from the company plan that you worked for. So if I'm 56, I retire, I leave a company and I roll that money into my IRA. IRAs don't have that option.

Bridget: Well, yeah, but if you kept your 401(k) at your current employer, you could probably roll over into that 401(k) old 401(k)s, like if you had something in there already.

John: Absolutely.

Bridget: Probably put most of your money in that 401(k), that is the 401(k)-type money.

John: But then you have to leave it there. And in our world, for you and I and a lot of people who are in the financial planning side of things, what do they recommend when somebody leaves their job? What do they do? Automatic, roll your 401(k) over to an IRA, so I can manage it for you. I mean, that's the default. And most of the time that makes sense. But in this case, you lose a huge opportunity if you roll your 401(k) over to an IRA if you retire after 55. I love the idea of consolidating. Most 401(k)s will take all the IRA money. It's a great place to put money then, because then you have access to it.

Bridget: Right.

John: The other thing I just want to point out about that rule though is that you have to leave the employer when you’re 55 or older. So if I'm 54 and I say, “You know what, I'm leaving this employer, and I'll leave my money in that 401(k). And then next year when I turn 55, I can take it out.” It doesn't work that way. You have to be 55 when you leave the employer. So again, it only fits a narrow slice. But man, if you're in that age range, it can really, really be a big deal as an advantage.

Bridget: Yeah. And there're two other ways that you can easily access money if you're younger than 55. The first one, which I want you to detail some more, is if you happen to have a 457 plan instead of a 401(k). So talk through that.

John: Yeah, thanks for bringing that one up. Living here in the Madison area, we've got a lot of state employees. And in Wisconsin, the deferred compensation plan that's run by the state is technically a 457 plan. And in general, it works like a 401(k), like a 403(b), generically speaking. It’s kind of the same thing, right? Yes. But for 457 plan, there’s a quirk in the retirement planning law.

Those plans do not have that 10% penalty before age 59 and a half at all. So you could be 40 and you don't have to leave that same employer. So if somebody's working around here for the state or for the university and has money in their 457 plan, in Wisconsin that's the Wisconsin deferred compensation plan, they can take that money out at any age with no penalty. I still have to pay taxes on it. But there's no penalty. And, as you know, Bridget, my wife left the state five years ago now already—time flies.

And we left that money in her 457 plan, because she's not 55, she's not 59 and a half. And we don't plan to use it, but we have access to it without any penalties if we ever need to it. But again, similar to that 401(k) age 55 rule, if we roll that to an IRA, we lose the opportunity. So it has to stay in the 457, but then you don't have age 55, you don't have when you retire. It's any time for that 457 plan.

Bridget: Okay. And now we've got one called substantially equal payments, which you've got some more experience with too.

John: Yeah.

Bridget: Just like the 457, if you happen to have one of those, jeez, you can take money out without a penalty anytime. It's interesting to me because I've helped hundreds of people retire, and many, many of them early. But we've never actually used substantially equal payments. And it's because usually people have money in different buckets. And so, if their goal is to retire early, they save some money in taxable accounts and they don't put it all in their 401(k)s or whatever because they know.

But a lot of times people aren't planning for this; it just happens. They get laid off or they've got to a health crisis or whatever. So there's plenty of times where it just happens. But again, in my experience, it's actually less often than you would think but nice to know that it's there. So talk through substantially equal payments.

John: Yeah, substantially equal periodic payments, rule 72(t) for the tax geeks who want to look that stuff up. And I just want to point out that if you're planning for this, if we're planning to retire at 53 or something like this, we build up other sources. But the studies show people tend to retire earlier than they plan to. Not always. But it’s not uncommon. And I'll just say it's complicated. So you've got to dig in. Never take anything we say here as advice, but especially not these highly specific things. But what it says is that, listen, I can take money out of a retirement plan of any sort, such as an IRA.

I have to take out a certain amount, and there're calculators that tell you what the amount is. It's like taking the required minimum distribution once you get to age 73 or age 75 in retirement. So there's a formula that says, hey, you have to take out at least this much, which is in some fashion an even amount over your life expectancy. And so, then we have to set it. I was just looking it up for somebody recently, and it's based on interest rates and some other factors.

But if somebody has $100,000 in an IRA and they want to use rule 72(t), they can take out something like $6,000 a year. I shouldn't say can; they have to take out something like $6,000 a year if they want to use the 72(t) rule. And then they have to take that money out each and every year for at least five years or until they're over 59 and a half. So if somebody's 50, they got to do it for 10 years. If somebody's 56, they got to do it for five years.

Bridget: Okay.

John: Again, there're ways you can do this. That's the one big takeaway I want to leave people. But especially with 72(t), there are some restrictions. You can't stop taking those distributions. You have to do it each year. So it's not ideal, but it's also a way that you can access money.

Bridget: Right. Another thing I want to mention is that we're trying to avoid early withdrawal penalties. So that's what we're really trying to avoid here. And another way to avoid some or all the early withdrawal penalties is to take a look at what the exceptions are and see which exceptions you fit. For many people, at least one of the things that they're spending money on is medical expenses. And I believe that's an exception. Now, the exceptions change, but they usually get expanded; they usually go more exceptions, not fewer.

So you want to look up the list and see what the exceptions are and make sure you just take advantage of that. So let's say you take out $10,000. Okay, gee whiz, you could have easily spent $10,000 on medical expenses. So that might be a great exception. But also, let's say you take out $10,000, but you spent $5,000 on medical expenses. Well, then you'd only have to pay the penalty on the part that didn't meet the exception. But there's a lot of exceptions.

John: That's right.

Bridget: It's worth taking a look at those exceptions. I would say that if you're in this situation, it makes a lot of sense to talk to a CPA or other tax preparer type and do some tax planning. It's probably going to be worth it because there's ways to get around these penalties, legally.

John: Right.

Bridget: But you probably can use some guidance to do it.

John: That's absolutely right. I'll throw out one more thing before we wrap up talking about how we access this money without paying penalties. There're some tools that not many people know about. But also keep in mind that when somebody needs money from their retirement plan before 59 and a half, oftentimes what that means is that they don't have income from other sources. I've lost my job and my income is going to be very low this year.

Bridget: Right.

John: We like to avoid the penalties, but sometimes taking money out and paying the penalty is a smart thing to do. If I put money into my 401(k) plan, and I save 24 cents on the dollar because I was in the 24% tax bracket and now I need to take out some money and I'm paying 10% taxes plus a 10% penalty, it might still be a decent deal. It’s not just tax planning, it’s financial planning too. Take a look at what you're trying to accomplish, not just avoiding that 10% penalty. And that'll put you in some good positions.

Bridget: Absolutely. So it seems like a great time to wrap it up. I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois.

John: And I'm John Scherer. I've got a fee-only financial planning practice in Middleton, Wisconsin. If you like what you hear on our show, Bridget and I are both taking new clients. We'd love to hear from you. But we're also both members of the Alliance of Comprehensive Planners. And if you'd like to find an advisor local to your area that thinks in a similar way that we do, you can check out acplanners.org.

Bridget: And don't forget to subscribe.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation. We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.