Early Retirement Planning: Taking Early Withdrawals Without Penalty From Your 401(k) or IRA

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A reader recently wrote me asking if there was any drawbacks to maxing out their 401(k) contributions as opposed to keeping the money in a taxable account. This is assuming you already have no debt, adequate insurance policies, and an emergency fund. Since his goal was to retire early, my initial concern was that the money would be stuck there until age 59 ½. (Why is it 59.5 anyways?) If you take money out of your retirement plans before then, you’d get hit with a fat 10% penalty on all withdrawals on top of the income taxes already owed. So perhaps it’d be a good idea to keep a chunk of money in taxable accounts for easy access?

But after some research it turns out that there are some exceptions to this penalty:

401(k) Early Withdrawals
If you have a 401(k), are at least 55 years old, and your employer allows it, you may be able to take out as much as you like without the 10% penalties. This is a case where you might want to keep your money in a 401(k), assuming that you are satisfied with the quality and costs of your existing investments. (You must quit at 55 years old or later, not any earlier. It’s a weird rule.)

IRA Early Withdrawals
Otherwise, once you stop working the best bet is to move your 401(k) funds into a Rollover IRA. A subsection of Internal Revenue Code Section 72(t) states that you can avoid early withdrawal penalties by taking “substantially equal periodic payments” (commonly referred to as SEPP or 72t withdrawals) for any type of IRA. The general rules for SEPP are as follows:

  1. You must make the withdrawals regularly, at least once every year.
  2. You must take them for either 5 years or until you reach age 59 ½, whichever is longer. Retiring at 40? You’ll need to make them for almost 20 years. Retiring at age 56? You’ll need to make them until age 61.
  3. You must wait until these equal payments end before you can start taking unrestricted amounts of money out of your IRAs.
  4. If you decide to do this, you can’t change your mind. If you do, you’ll owe a 10% penalty retroactive to your first withdrawal, plus interest!

You must also calculate the amount of your SEPP according to three IRS-approved methods: required minimum distribution method, the fixed amortization method, or the fixed annuitization method. Let’s say you have a $1,000,000 IRA right now at age 55. Without going into the details here, here are the amounts according to this Dinkytown 72(t) calculator, for a single life expectancy at the current maximum “rate of reasonable return”:


An added twist? If you have (or want to make) multiple, separate IRAs, you can take SEPPs from any or all of them. So in essence, you can withdraw anywhere from 0% to possibly 7% of your retirement balances annually. Naturally, you might not want to take too much out too early lest you run out of dough. But to me, this takes away much of the fear of having a large percentage of my money held hostage in my 401ks/IRA accounts if I decide to retire early.

I still need some huge balances to pull such a feat off though. For example, several studies suggest that a conservative withdrawal rate for a 40-year period is ~4% of one’s balances each year. I just need $3 million dollars in balances by the time I’m 55 to take out $120,000 a year (an estimated $56,000 a year in today’s dollars), and I’m all set! No problem…

For more information, here is one detailed resource I discovered from the Retire Early homepage.

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  1. Thanks for the post! Although its reassuring to know that I could take money from my retirement funds early… I am still unsure whether or not I should necessarily max out my contributions at my age (23).

    Saving for retirement is part of my budget, but if I max out my contributions, thats a HUGE amount of money that I wouldn’t be able to touch for 30+ years.

  2. One clarification on the age 55 rule for 401(k) withdrawals. As I understand it, one can only withdraw money penalty-free at 55 if the employee has “separated from service” after age 55. So you can’t just leave your employer XYZ at age 50, work somewhere else, and then expect to withdraw the money at age 55 penalty-free from your XYZ 401(k) — you can only do that if you leave XYZ after you turn 55.

    Of course, at any rate, you can tap it penalty-free at 59 1/2.

  3. Correct me if I am mistaken, but if you had enough liquid at the time of early retirement, you could recharacterize your rollover IRA to a Roth IRA, under which you will then have access to the contributions (initial rollover amount) without penalty.

  4. Jonathan,

    You say “If you have (or want to make) multiple, separate IRAs, you can take SEPPs from any or all of them.”

    How can you make multiple IRAs? Can you split up one big IRA into several smaller ones? Can you move PART of a IRA from say Vanguard to Fidelity?

  5. S.B. is correct about not quitting earlier than 55, I have added that in. Also added a link to IRS.gov for reference.

    Yes, I believe one can do partial rollovers from one IRA to another. You have to take the same precautions as 401k – IRA, like doing it within 60 days and not taking possession of the balance yourself, etc.

  6. InvestEveryMonth.com says

    I’m still fairly young so it is nice to be reminded about issues I may face in the future. It is motivating me to invest more now so my options in a few decades will be win win scenarios.

  7. O.K., call me crazy but I have some optimism about taking out funds early. It all depends on how you use the money.

    Let’s say, for instance, the housing market hits pretty close to bottom in 5 years. And you take out $50K from your retirement account to make a down payment. So, you lose 10%, plus you will pay the income tax that you would pay anyway — sometime in the future. In those 5 years, your money got to grow tax free, earning you, even conservatively, 25%, so that more than covers the penalty. And if you are using the money to buy real estate, then you are moving one investment to another.

  8. Dennis- Would having a “HUGE amount of money” in retirement be such a bad thing? At your age, you’re probably best off first putting in enough to get the employer match (free money). After that, contribute to a Roth IRA (especially at your age). Beyond that, contributing further to your 401K would depend alot on your situation. I was lucky enough to be able to max out mine at around your age, and remember that it felt like alot at the time, but chances are, your salary will increase faster than the contribution limit, and it isn’t long before you wish you could contribute more…or that you had contributed more earlier.

  9. Here’s one concern about the details of the rules … you’re looking at 2007 law, not 2027, and it’s pretty likely that details of 401(k) or IRA law will be rewritten in the future.

    While I think the main features probably won’t change (tax deferred/free investing with limited withdrawal options until retirement), I don’t hold my breath that any of the existing withdrawal details will stay the same, especially as more people who are plan participants start retiring in the future and begin to withdraw funds.

    It would be interesting to find out in what time intervals these rules have substantially changed since 401(k)’s became law some 30 years ago, and if plan participants were grandfathered into the old rules for existing accounts.

  10. Steve Austin says

    Agree w/ Mike re: wishing to have contributed more earlier: I made my first IRA contribution in March 1994, for tax year 1994. It wasn’t until several years later that I learned I could have made a contribution to tax year 1993 at that time (up until April Tax Day 1994). I lost out!

  11. mimi- You’re crazy! 😉 Seriously, though, having the same amount 5yrs later is not breakeven. You have to consider inflation, as well as the opportunity cost of having that money invested outside a 401K penalty free. Penalties are just that…no matter how you slice them.

    Of course you can take out up to $10K for a house purchase penalty free. And your employer may allow you to take a loan against it, but you must repay it if you change jobs.

  12. elizabeth says

    Hi! I’m a huge fan of your blog. I’m not eligible for my 401k yet but I’m also 23- like Dennis- and hope to at least get the match from my employer.

    I saw this article on MSN about how to marry a billionnaire- http://today.msnbc.msn.com/id/19505458/?GT1=10150 – and thought it was funny (albeit sad if you think about people bookmarking this article as a reference). I guess it just goes to show that people are looking for financial freedom in many different ways!

  13. My understanding is that Roth 401(k) accounts have different “nonqualified distribution” rules which are less-penalizing. My employer doesn’t offer them so I am not super-familiar with the details… does anybody else have any experience here?


  14. Mike – I disagree with that. Who says you will live beyond 59? I have a family history of breast cancer and my mother died at 57. If she’d been scraping all her life to be rich in retirement, she would have missed a lot of the fun. And besides, if you do live frugally all your life, you will be so used to it that you don’t need all that money (think of those people who never waste anything because they ‘lived through the Depression’).

  15. Yinna expresses some of the concerns I have.

    I can max both my 401K and Roth IRA contributions with enough money to live frugally. Which is something I don’t mind doing… but it would be nice to have extra cash to do random things… like a tip to some distant country.. haha

    I guess its a matter of preference. I wish I knew what would happen in the future….

  16. Hey guys, take advantage of your current circumstances!

    First, don’t worry about getting money trapped in until later because if you SAVE EARLY you can stop saving *entirely* in a few years and still have enough money for retirement.

    We are maxing out a 401k, a SEP-IRA and 2 Roth IRAs because it’s a foolish time to buy real estate. If we choose to buy a house later on (we’ve got down payment money and could take some from the Roths) we’ll reduce the savings and have more free cash to pay monthly.

    Alternatively, if you have saved a LOT of money for retirement the conventional wisdom of paying off the mortgage in old age goes out the window…finance that house and pay for it easily…plus get the mortgage interest deduction.

    When life gives you lemons make lemonade. When it sucks to buy real estate get whatever deduction you can. Don’t follow conventions, roll with the punches.

  17. sprintie says

    Is a 401k only valuable if you are planning on having a long-term relationship with a company?

    what if:

    a) you are planning on staying one year with a company, during which time, you won’t get to their minimum time to be vested?

    b) you are planning on staying two years with a company, during which you would only have been vested for about 6 months – what happens in these scenarios to the money you have submitted to said company’s 401k plan?

  18. Yinna – I think you have missed the point of this thread. It’s not about living it up while you are young, or being filthy rich when you retire at 65. It is about retiring early, and strategies to that end. If you are the ‘carpe diem’ type, or define yourself by your work, then the information that Jonathan presents here will likely not be relevent to your situation. I have a family history of heart disease, diabetes, etc, but this affects my lifestyle decisions, not my financial ones. I have to assume that eating healthy and exercising as well as progresses in medical science will allow me to live to 100+, so I must ensure that my money will last that long before deciding to retire at 40. Funding 60yrs of your life with 17yrs of savings requires quite a bit of sacrifice, as well as a commitment to living frugally in both your pre and post retirement life. It is obviously not for everyone.

  19. question i have a 401k. i want to by a house and need some money down. can i take out of my 401k to buy a house without that money being penaliesd. im 41 years young. thanks

  20. JohnDaniel says

    I’m probably beating a dead horse here but here goes.

    I’ve worked for the same company for the last 25 years. I’m in a 401k plan and have a company pension plan. One year from now, at age 58 1/2, I want to retire and start withdrawing on the 401k and/or lump sum pension fund payout. I obviously need to roll over the majority of the money into an IRA but also need to keep enough for 1 year’s living expenses (until I hit age 59 1/2). Can I do this without taking that 10% penalty on taxes? Also, is there any advantage to taking the withdrawal from the 401k vs. the lump sum (or vice-versa)? Thanks.

  21. I’ve got a pot full ‘o 401k money that I expect to access when I turn double nickels. I’d like to pay down some seriuos debt in the first year. I hear/read that I can keep my money in my employer’s plan and take out money with impunity. Is this for real? Seems to good to be true.

  22. My credit card company just bumped me to a 29% interest rate…due to an address change- long story.
    I’m considering taking out enough from my 401-k to pay the card off. Is this wise, considering the 10% penalty plus taxes (that I’d pay anyway) v.s. 29% interest rate? It seems so. And, does anyone know how to address the issue with the c.card company re: credit scores, reduce the rates, etc?
    I’m new here, so I apologize if I’m out of turn. I read all the emails and this seems like a great place to ask the question.
    Thank you,

  23. So, if I want to retire at 49 and all of my money is in a 401K, can I move that to the IRA without penalty to be able to take equal distributions to live on?

  24. Jerry – Depends on the employer plan. Some have fees after you leave.

    Jeff – Tough question, I’ll have to ponder that one.

    Peskie – Yes, it would appear so.

  25. There are loan opitions on some 401K plans to avoid the 10% and as I read IRS tax code ,you must take the equal installments/distributions on a five year or until fifty-nine and a half years of age (which ever is greater). So therefore if you get in on the early retirement plan ( prior to fifty-nine and a half years of age) your stuck for five years of taking this amount. Can you take more? Why would someone not rollover into an IRA? It seems to me that you avail yourself of more choice and hence the more options, the better for the consumer. My experience has been that I have been able to be more aggressive and been better rewarded outside the 401K plan. Getting ready to retire in 4 years at 55 and have the metrics. $1150 a month per every $200,000 of 401K. The 401 will provide $1150 and the IRAs will be $3450, which is three times as much as the 401K. My biggest burden will be taxes and the cruel taxation of half of my social security upon reaching 62. Does anyone know if pension and or ERISA is considered earned income? Seems that this is a method of means testing which discouraging to savers. Therefore it is my misfortunate to spend non retirement investments to lessen the tax burden. This is also the same mentality which is used to dole out Medicare medication payments. They are encouraging folks to spend and the dear old government will pay for your drugs. So the calculations should be made as to how much will my uncle Sam allow me to take out before uncle Sam will start taxing my social security. My guesstimate is $34,000 a year (married couple), after that your social security is taxed. Never mind the fact that you took a 20% reduction as an early retirement penalty, which is just/fair. So therefore your going to take a penalty for not going at 70 in anycase. However, many call it a bonus if you stay past 65 and age creep.

  26. starhusker says

    Hi Jonathan, let’s take a look at the following strategy:
    1) principal of Roth IRA can always be withdrawn without penalty
    2) once you want to retire, you can rollover your 401k to rollover IRA.
    3) anyone can convert a traditional rollover IRA to a roth IRA after 2010.
    4) the conversion amount is free to withdraw without any penalty after 5 years.

    so, as long as you have enough (in taxable or in Roth principal) to use in the first 5 years, you are pretty much all set. Am I missing something?

  27. I think we miss an important point. That being that one is better off if they don’t take distributions which would put them in a higher tax bracket and or distributions which allow the taxation of their social security benefit. Such would be the case if you had to take 401K and or IRA which were over funded. So careful planning should go into these plans as well as other assets in order to maximize income and minimize taxes. Therefore, one could make the case for living too frugally and illogical hardship. All brokers and or fund management companies are out to get into your pocket and therefore want to get you to put away the maximum amount. They live off commissions and if you allowed them, they would churn your assets without just cause. Just for the sake of boosting their income/commission. Your interests should be their number one concern. However, we live in a society which has had to institutionalize ethics as a requirement for folks dealing with the assets of others. Its silly to think a college class in ethics is going to change Enron and or a Wall Street CEO culture that preys upon innocent people. If there is a true argument for capital punishment its is here. If capital punishment doesn’t deter this well calculate white collar crime, certainly the posh country club prisons aren’t. Bottom line is that hard working folks need to watch out for their own interest and quit trusting others.

  28. Reference early retirement: Topic 558 in the IRS tax code states that you must retire “in the year” in which you turn 55 to avoid the 10% penalty for early withdrawal 401(k), not “the day” you turn 55.

    Example: Your 55th birthday is in October 2009. You can retire in January 2009 and qualify for the exemption… but you must “retire” in the calendar year in which you turn 55.

    If you had a pension, you could roll the pension into your 401(k) at retirement and then have unlimited access to your without the 10% penalty. Otherwise, you must check out the 72(t) exceptions for equal payments until you reach age 59.5.

  29. I am 55 and thinking of retiring soon. I don’t need all the money I could recieve from a 72T plan. However, one never knows what the next five years could bring. Is there any advantage or disadvantage to taking out as much as I can or should I only take as much as I estimate I will need for the next five years.

  30. If I start taking Substantially Equal Periodic Payments from IRA account at age 55 and then decide I would like to go back to work, can I continue to withdraw without penalty or do I incur the 10% penalty. Can I go back to work?

  31. Okay this question has probablt been asked a million times I just couldn’t find the answer. I want to know if at age 59.5 can I start taking withdraws from my 401k even if I am not retired? I’m assuming I can without paying the 10% penalty but I will have to pay state and federal taxes plus the sum will get tacked onto my annual income. I’ve been thinking about doing this between age 59.5 to age 62 so I can have the house paid off and retire at age 62 instead of age 65 whereby I may live long enough to enjoy life instead of just eat, sleep and work until the grave as our new non define pension program slave labor work force is going to have to. Please advise ASAP.

  32. S. Birnbaum says

    I’m @58 and on SSDI. I have 401ks and moved money into an IRA as well.

    If I choose to take out say $15000 or $20k/yr when I reach 59.5 or 60, will I be penalized (pay additional taxes) on that money on my taxes. Is withdrawing the money considered income? In both instances, I would go over the magic SS earnings income of $25k and we’d like to do house updates (a few $k) and purchase a cheaper used car.


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