Is retiring early one of your financial goals? If so, there are important tax implications to consider as you approach an early retirement.
Your Lifetime Savings
Think about where you have your retirement savings. Are most of your assets in your company’s 401(k) or 403(b)
retirement plan? Leaving you with little to no liquid assets available to fund your living expenses post-retirement? This dynamic is a common mistake that many people make, despite their best intentions. All throughout our working years we are conditioned to save into our 401(k) plans, but early or unexpected retirement might thwart the efficacy of that plan in retirement. Withdrawing from a 401(k) or 403(b) plan prior to age 59.5 normally incurs a 10% penalty in addition to the ordinary income taxes that are due.
Rule of 55
However, there is a little-known strategy called the “Rule of 55”
that may be used if you leave your job in the calendar year you turn 55 or later. The Rule of 55 allows you to withdraw from the 401(k) or 403(b) without the 10% early-withdrawal penalty. You only pay the usual ordinary income taxes. It provides flexibility that it doesn’t make you commit to a set schedule, and you can withdraw as much or as little as you need. While this planning tool sounds wonderful there are drawbacks. By pulling out retirement funds prior to age 59.5
, you lose out on long-term growth. These unexpected early withdrawals may not be supported in your long-term financial plan, and the Rule of 55 only applies to 401(k) and 403(b) plans, not IRAs. Note also that not all plans offer this election, so the first step is to contact your plan administrator. When approaching an early retirement, it is always a good idea to have an in-depth discussion with your financial advisor and CPA prior to making any financial decisions, including the Rule of 55 election. Discussing your financial plans with a knowledgeable advisor and CPA will help you gather all the relevant information you need to make the most informed and strategic decisions for maximizing your savings both before and after retirement.