If you want to retire early, you absolutely need to avoid early withdrawal penalties when it comes to your retirement accounts. In fact, many early retirement withdrawal strategies will crush your savings! Worse still, they can get you into tax trouble. Needless to say, it’s best to sidestep them whenever possible.

The tax penalty for dipping into retirement funds early is a whopping 10% in most cases! That means you could be trimming your precious savings with every penalized withdrawal before age 59½. This applies to all qualified retirement accounts, including 401(k), 403(b), Traditional IRA and Roth IRA accounts.

Thankfully, there are no shortage of creative ways to access your retirement savings without incurring huge penalties. Whether you retire a few years before 65 or are fortunate enough to retire in your early 50s, there are strategies you can explore. Here’s a look at some of the most common.

A man pondering his early retirement withdrawal strategies

Early Retirement Withdrawal Strategies: Rely on Non-Qualified Funds First

The first and best thing you can do to avoid early withdrawal penalties is to avoid withdrawals altogether. Before you dip into your qualified retirement accounts, rely on non-qualified funds first. Depending on the allocation of your wealth, this could mean one of several different strategies:

  • Rely on passive income from a dividend-focused investment portfolio. Often, these dividends get taxed at a lower rate than ordinary income. This allows you to maintain a steady, passive income without liquidating any securities.
  • Liquidate long-term investments. For most people, this will incur a 15% tax rate. While it seems counterintuitive to sell stocks and pay 15% as opposed to a 10% early withdrawal penalty, there are some benefits to consider. For example, if your income is below $40,400 ($80,800 married), that effective tax rate falls to 0%! Moreover, you can also liquidate portfolio losses to offset capital gains.
  • You can sell your home to take advantage of the equity. This can often provide an immediate influx of cash to bridge the gap between an early retirement and the age threshold for qualified withdrawals.

While these aren’t necessarily ways to circumvent early retirement penalties, sometimes the best course of action is avoidance. If you can help it, try not to touch your retirement accounts until after age 59½. As you can see, most early retirement withdrawal strategies come at a price.

Consider 401(k) or 403(b) Withdrawals After Age 55

Despite an age threshold of 59½, there is actually a way to dip into an employer-sponsored retirement fund early, at age 55. If you retire in or after the year you turn 55, the 10% penalty doesn’t apply to distributions from these plans. This is something to consider if you’re looking to exit the workforce a decade earlier than normal.

It’s important to note that there’s a tradeoff that comes with this strategy. Savvy retirees might want to roll their employer-sponsored plan into a self-managed retirement account like an IRA. If you choose to do this, you cannot take penalty-free distributions until age 59½. The tradeoff is that you gain the power to continue investing your retirement funds with more investment vehicles than a traditional 401(k) plan might offer.

Qualified Distributions From an IRA

If you’re leaning on an IRA for retirement and plan to retire early, there are some options for avoiding penalties. You need to investigate qualified distributions. If you have a Traditional IRA or you’ve contributed to your Roth IRA for at least five years, you become eligible for qualified distributions under certain circumstances:

  • You’re at least 59 ½ years old
  • You’ve died and have named a beneficiary for your IRA
  • You’ve recently qualified as a disabled individual
  • You’re buying your first home (up to $10,000 withdrawal limit).

Unfortunately, most of these won’t apply to a retirees, unless you happen to be buying your very first home. The one that might be applicable involves a declaration of permanent disability. If you’re retiring early due to a disability, this becomes a viable option for tapping into your retirement funds penalty-free before age 59½.

Substantially Equal Periodic Payments (SEPP)

The last and most popular method of avoiding early withdrawal penalties is through Substantially Equal Periodic Payments (SEPP). This strategy is in compliance with the IRS’ section 72(t)(2) rule. To capitalize on penalty-free withdrawals from a qualified retirement account, you need to follow a strict schedule set by the IRS. There are three options:

  • Required Minimum Distributions (RMD). This formula uses your age and year-end account balance to determine the withdrawal amount. You’ll need to recalculate it each year you take SEPP.
  • Amortization. This strategy creates an average life expectancy table and generates a payment schedule based on your most recent account balance. It works similar to a mortgage amortization table.
  • Annuitization. This is the same formula used to generate a pension payment or life insurance annuity payout. It’s based on a current IRS annuity table and your most recent account value.

You need to follow the SEPP program for a minimum of five years or until you turn 59½. Deviating from the plan will incur the 10% penalty and potential additional penalties.

Avoid Fees at All Costs

Early retirement withdrawal strategies are a must-have for anyone retiring before age 60. Without hyperbole, the tax penalties associated with unqualified distributions can ruin your retirement. Do everything you can to plan for and avoid these fees! Explore the strategies above and consult a tax professional to ensure your hard-earned savings stay in your account and aren’t lost to Uncle Sam.

As a brief disclaimer, it’s always best to discuss these strategies with a Certified Financial Planner and/or a tax professional. Some strategies may not apply to you, while others might be more advantageous for various reasons. Every individual’s situation is unique and warrants personalized consideration.