Bridget Sullivan Mermel and John Scherer discuss the 59 and a half year age rule for retirement account withdrawals. They highlight exceptions to the rule, such as being able to withdraw from a company retirement plan at age 55 or later. They also mention the importance of understanding the incentives in the financial industry that may lead advisors to recommend moving money into an IRA. Additionally, they touch on the option of substantially equal periodic payments for early withdrawals. Overall, they emphasize the need for individuals to be aware of their options and make informed decisions about their retirement accounts.
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TRANSCRIPT:
Bridget: Hey, John, most people think that you can't take money out of your retirement accounts until you're 59 and a half, but that's not always the case. That's going to be our topic today on Friends Talk Financial Planning. I'm Bridget Sullivan Mermel, and 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. Before we start digging into retirement distributions, I want to remind everybody to hit that subscribe button. Subscribing helps other people find our information on YouTube and helps us rise in the algorithms. And with that, I'm looking forward to having this discussion. It's interesting, Bridget. There is a 59-and-a-half-year age rule. Many people know about that. They don't know, however, about the exceptions, and not many financial advisors tell their clients about this for various reasons. We can get into some of that, too, but I think it's going to be a fun conversation.
Bridget: Yeah, exactly. And I think that some people are afraid to retire. And so, this has got an actual impact on people's lives. So why don't you go over the first big thing that a lot of people don't realize?
John: Yeah, sure. Let me just dig into some of these rules. The 59-and-a-half-rule, just to be clear on what we're talking about, is that if you take money out of your retirement accounts before you reach age 59 and a half, there is a 10% penalty in addition to the taxes on it. So it's this 10% penalty rule before 59 and a half. But there are some exceptions to that rule.
And one of the major exceptions that can really make an impact for a lot of our viewers is that if a person retires at age 55 or later, they can take money out of their company retirement plan—401K, 403B—provided they retired after age 55, so between 55 and 59 and a half. That rule doesn't apply to IRAs, though. If I've got an IRA, I've got to wait till 59 and a half. If I've got my company's employer plan, like a 401K, and I retire at age 55 and a half, I can take the money out of there with no 10% penalty. And that's just a really big one that gets overlooked a lot.
Bridget: Yeah, and I think people don't know about it. And there's this feeling in general of saying, “Oh, I got to get my money out of my 401K and move it into an IRA. So let's talk a little bit about that. Where is that coming from?
John: Well, I think that's promulgated by a lot of the financial industry because many people in our world get paid by having your money underneath their umbrella. And so, if the money is in your company 401K, then an advisor can't charge you on that or doesn't make any money on that, so they make money by rolling it out into your IRA. And so, people get advised to take money out of their plan and put it into their IRA. And that's not to say that that's bad advice. That's the right advice in many situations, maybe even most situations, but if I’m in this spot where I might be retiring before I'm 59 and a half, and I might need some of that money that's in my 401K plan, leaving it there is often the best deal, or at least it gives you flexibility.
And I know somebody who was working with one of the major brokerage firms, and they were sort of doing it themselves, and they had an advisor at this national brand say, “Hey, you get free advice from us if you work with us.” And I was talking with him, and he said, “Yeah, I got to wait, and when I'm 59 and a half, then I can start doing this.” I said, “Well, golly, you don't need to wait that long.” The people at the major brokerage firm had never told him that if you leave money in your 401K plan, you can have access to that before your age 60. He thought he had to work that long.
Bridget: So question for you. What if you quit or stop working when you're 53, keep the 401K, and then really retire and want to take money out at 55?
John: Yeah, so great. Some clarifiers on that. That scenario you described doesn't work. It's not like I can leave money in my 401K, and then when I get to 55, I can take it out. It's if I'm 55 or older and I've got money in that 401K plan. So again, I have to be 55 or 56 or 57. If I'm 53 and I retire, I don't have access to that exception to the rule, then it probably makes more sense, or at least more reasonable, to say, “I’m rolling into an IRA.” It's when you're 55 that you lose the option for that.
Bridget: Right, okay. And then the other thing is that I really appreciate your why do people not know about this? The answer to that question is that there's a lot of incentives in the industry to recommend people move their money into the IRA, so much so that it becomes automatic.
John: Right.
Bridget: And there're new rules with the Department of Labor in our industry that you have to show that it makes sense. However, generally, that's not that hard to do.
John: I think you're exactly right. Our industry is wired in this way; it’s designed to be that. But I want to be objective as much as we can and say that in many cases, again, maybe most cases, rolling your 401K into an IRA is a very reasonable move. If you're under 55, you don't have the option to do this plan. So if you're 35 or 45 or 50, it takes that away. If you're over 59 and a half, you don't need that option anymore. So it's this slice, and it might sound like a small amount, but there's a lot of folks who I have talked with over the years who are in that range.
And even if they don't need the money, it can make sense. We’ve got a client who’s been with us for a long time. He’s way older than 59 and a half now, but at the time he said, “I don't think I need this money, but why would I give away that option? Why don't I keep the money in that old 401K because I'm retiring at 56? And then if life changes (things change more than they stay the same) I've got that safety net. I can access that.” And this kind of leads me into one other point that I wanted to make for folks.
I'll tell a personal story. My wife Allison stopped working. She had worked her entire career for the State of Wisconsin, and when she retired from there, she got a deferred compensation plan, like a 401K, but with state and local governments the main plan is called a 457 plan. For most purposes it's like a 401K, like a 403B, you don't need to know the differences, but there is one technical difference. For state employees, if you have a 457 deferred comp plan, there is no 10% penalty for early withdrawals, no 59-and-a-half rule. Living in the Madison area, there are a lot of state employees who have that option if you got that deferred compensation plan. You could be my wife in her early 50s. We don't need that money now.
We don't think we're going to do anything with that money, but what if things change? If I get hit by a truck and we need some cash, we've got the flexibility that we can tap into Allison's 457 plan in case of emergency. There's no reason to roll it into an IRA at this stage. And that's another one of those things that people don't tell you. And again, I'm particularly sensitive being in Madison with the state capital here. When taking money out of your 457, this isn't an age 55 deal. This is at any point in time. Why would you roll it over? If advisers aren't thinking about that option, they're really doing a disservice to clients.
Bridget: I absolutely agree. And there's another exception, too. So let's talk about that third exception.
John: Yeah, well, there’s one other thing that you can have access to. If you're at a company age 55, great. If you got a 457 plan, that little technical difference—lot of flexibility. But there's one option and you can get it from IRAs or any other place. It's called the Substantially Equal Periodic Payments withdrawal method. SEPP is the acronym that the IRS uses for that. And I'll just give you the Reader's Digest version first, Bridget. Taking money out of that way is very complicated and very rigid and you can muck it up.
It’s not like it can't be done, but basically, you have to take out an equal amount of money based on actuarial tables for at least five years, or until you reach 59 and a half. So it can fit a place, like if I don't have a company retirement plan, everything's already in IRAs, and I need money at 56 or something like this. So there is a way you can get it out using a series of substantially equal periodic payments. But golly, I don't think I've ever helped anybody do that because some of the rules are really stringent and if you break them, there's some pretty big consequences, so usually we try to avoid those things, but it's important to know that it is out there.
Bridget: And I want to just mention these exceptions get into situations like if you have a medical emergency or cerebral diagnosis, etc. There are exceptions to getting money out of 401K that you can look into. And again, what you avoid then is the penalty. You don't avoid paying tax on it.
John: That's right.
Bridget: And so, if you're in that situation, or even if you think you might be in that situation, you want to want to dig into the rules and find out if you can get the money out without paying this penalty.
John: You just reminded me of something, Bridget. Thank you for reminding me. This is my discussion, or what I was referring to when I said, “I'm getting to retirement, and I'm using this money. I don't have to wait until I'm 60.” There're other options in medical emergencies and other places. This is not the only thing. And I will say that, especially at age 55, when getting money out, the intention is not, “Well, I haven't saved enough to buy my new car, so I'll take it out of my retirement plan.”
No, the money in your retirement plan is designed for retirement. This is not meant to be an easy access just because I didn't take care of my other responsibilities. So it's not just a free pocket of money. Rather is a matter of saying, “I'm going to be retiring, I'm in a position to do it and maybe work part time before I'm age 60. How can I do this effectively?” There're ways to do it. And don't think of it as saying, “I'll just tap into my retirement plan to take that trip.” That's not the intention for my discussion on this.
Bridget: Yeah, very good. So I think that's a great time to wrap it up. John. 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. Both Bridget and I are taking on new clients. We'd love to hear from you if you're interested in talking with us as an advisor. And we're also both members of the Alliance of Comprehensive Planners, so if you like what you hear on our show, but you'd like to look for an advisor in your local area, check out acplanners.org
Bridget: And please 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.