Retiring Early: New IRS Rules Could Mean More Money In Your Wallet

The Great Resignation is translating into a flood of early retirements. When people decide to retire suddenly, there are challenges and roadblocks that can cost the retiree dearly. Many of these challenges are dependent on what age you are when you leave employment. For example, you can’t access your Social Security until age 62, and even then, your benefit will be at a steep discount. Further, you can’t sign up for Medicare until you’re age 65.

The biggest age challenge for many early retirees is that you can’t withdraw your own retirement savings until you are age 59½. Unless you qualify for an exception, any withdrawal from your IRAs and 401(k) accounts will result in a 10% tax penalty on each withdrawal.

In a January announcement, the IRS stated that it will make this penalty a little less troublesome. Retirees who are leaving the workforce before age 59 ½ will now be able to take out more money without incurring the 10% penalty.1

Substantially Equal Periodic Payments (SEPPs)

You can choose one of three different methods to help determine how much to withdraw and still stay within the SEPP rules:

  1. The required minimum distribution option (which generates a lower initial withdrawal than the other two methods)
  2. The fixed annuitization method
  3. The fixed amortization method

With the fixed amortization method, your annual payment is determined using your life expectancy and a permitted interest rate. Because of the recent changes the IRS made, this calculation offers a significant increase in the amount you can withdraw each year without incurring the 10% penalty. In general, once you figure out how much you’re going to withdraw, you must stick with the method you’ve chosen for a period of five years or until you turn 59 1/2, whichever comes later.

Proceed with caution

Many financial professionals discourage the use of SEPP withdrawals, cautioning that many things can go wrong with this strategy, including:

  • Recognize that while these payments, properly calculated and executed, help avoid the 10% penalty, they are still subject to ordinary income taxation.
  • Once you’ve committed to taking these distributions, with few exceptions, you’re obligated to stick with the withdrawals.
  • With SEPPs, you may be committing to a strategy that may run out your retirement savings before you die. Just because you can now withdraw more each year doesn’t mean you can afford to draw that much.

Early retirement is an exciting opportunity for many, and the pandemic has hastened this move toward freedom from employment. Helping this trend for those retiring while still in their 50s, the IRS allows them to get far more of their retirement savings penalty free. But proceed with caution. If you’re going to use the SEPP strategy to access your qualified retirement savings, be smart. Get your numbers right, follow-through on your withdrawals each year, and don’t put yourself in the situation of running out of funds later in your retirement.

  1. https://www.irs.gov/pub/irs-drop/n-22-06.pdf

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