Withdraw Your Retirement Accounts In Your 30s. No Taxes. No Penalties. - Retire29 (2024)

Withdraw Your Retirement Accounts In Your 30s. No Taxes. No Penalties. - Retire29 (1)

I’ve been writing a contract proposal for my 9 to 5 this past week. Unfortunately, this kind of proposal isn’t as easy as this kind of proposal–which I loved writing–so it hasreally taken away from my Retire29 schedule. Ten days without a post is rough.

Anyway, let’s get to it.

First, a disclaimer. This article is about filing taxes on your own–a topic that I absolutely love. As far as I’m concerned, an effective tax strategy beats an effective investment strategy any day of the week, because there’s no better return than making 25% overnight (or whatever your marginal tax rate is), by legally avoiding taxes. Specifically, this article is detailing my well-researched plan on how I’ll be withdrawing my entire Traditional IRA and 401(k) while in my 30’s without paying income taxes or penalties–thereby making my very early retirement possible. This plan has been fully vetted by Wesley Snipes the internal revenue code, which I cite throughout. However, taxes are a lot like fingerprints–they’re a little different for every person. Find an answer to the question: how do umbrella companies work? They will handle all the accounting for you. So, I can only write about my situation, and I hope youreaders can takethe lessons therein and use them in yourown approach.

The 401(k) Problem

401(k)s are a pretty fantastic little creature. They’re easy to enroll into, they often come with a company match, they increase the value of your paycheckthrough tax avoidance, and the money is saved before it is available to you–a classic “pay yourself first” savings strategy. Th3 401(k) is precisely why something like 60% of my investments upon retirement will be in 401(k)s and Traditional IRAs (fromrolling over old 401(k)s).

A commonly citedproblem with these tax-deferred accounts is that the money is tied up until one turns 59 1/2. Withdrawing your money before age 59 1/2 results in not only the owing of ordinary income tax, but also a 10% early withdrawal penalty. This desire to avoid the penalty is an oft-cited reason for needing to work longer. A early commenter to Retire29, Heather, spoke of this withdrawal restriction and lamented it as her reason for needing to work much longer. I’ve owed her a thorough response to this issue.

Then, a couple months ago, I was having lunch with a buddy of mine who spoke of the same restriction. It has even pervaded the financial blogosphere. Last week, my brother asked me about it. It’s a problem with seemingly no easy answer…until today.

I encourage you to read through this, as there’s a pretty big, yet simple “bottom line” that I’ll conclude with at the end that mayreally change how you approach your early retirement savings.

How To Do It

This is approximately how my retirement savings (and income from that savings) will look when I retire. Don’t get too hung up on the exact numbers or even the date, though, because the strategy is agnostic of the account balances or the date it begins.

As you can see, I’m heavy into accounts where my money is off-limits to me. The only money that is immediately accessible (unencumbered) will bemy current income (couple rental properties, writing income, maybe some part-timing work), my taxable brokerage, and my Roth IRA deposits. As most of us know,contributions to Roth IRAs can be withdrawn at any time and for any reason. As such, my only fully unencumbered funds (at this point) will be just my taxable brokerage balance and about one-third of my Roth.

First Action:

The day after I retire, I’ll go ahead my move my Roth contributions over to my taxable brokerage. Because these are just the Roth contributions (not the earnings), then this is not a taxable or penalized event. I’ll also move my entire 401(k) balance over to my traditional IRA (which is where I do my dividend growth investing). The common tax-deferred structure of both 401(k)s and Traditional IRAsmeans that there is no tax event or penalty owed to the IRS for this move (as long as the rollover to the IRA occurs within 60 days of the 401(k) withdrawal).

Second Action:

The second step, which will occur at about the exact same time as step 1, is to move roughly $60k from my Traditional IRA to my Roth IRA. There is no 10% penalty for this conversion as long as the deposit to the Roth IRA occurs within 60 days of the withdrawal from the Traditional IRA. However, this moveis a taxable event.Traditional-to-Roth conversions count as ordinary income, so I will owe tax on this conversion for my 2020 return. I will repeat this ~$60k conversion each year into perpetuity, until the Traditional IRA balance is zero. Likewise, I will owe income tax each year on that ~$60k, as well. I say that I will owe income tax, but I describe later down below that I probably won’t. Please read on.

It is important to note that the only money, still, that I can use for living expenses is what is in my taxable brokerage (~$145k). Recall that I have already moved my original Roth contributions over to my brokerage account (Action 1), so my entire Roth is still off limits. Until…

Third Action:

Enter the 5-Year Roth IRA conversion rule. This is described in vivid detail in Internal Revenue Code 408A, but it says this:

  • Any money converted from a Traditional IRA to a Roth IRA can be withdrawn from the Roth IRA after five tax years without penalty.
  • Since income taxes were paid upon initial conversion to the Roth IRA, no taxes are owed upon withdrawal from the Roth IRA.
  • Fivetax years means that any conversion made at any point in acalendar year is assumed to be made on January 1st of that calendar year. Theoretically, if I convert funds on December 31st, 2020, I can withdraw those funds on January 1st, 2025 (4 years and 1 day later)
  • Each conversion made is subject to its own five-year period.

I will withdraw from my Roth IRA the conversions I made in Step 2. Assuming (from step 2) I converted $60k each year starting 2020, then I’ll withdraw $60k each year starting 2025. I will continue these withdrawals from the Roth IRA until the balance of the Roth is just the earnings. As long as I follow this five-year waiting period, then there is no penalty for this withdrawal of converted funds–even though I’ll still be way under age 59 1/2.

Wait??? What about those taxes?

Recall from step 2 those conversions in 2020 and onward of $60k per year. Those are subject to ordinary income tax. But, I said tax free, right? Okay, so here is what my 1040 willapproximately look like in the years 2020 and onward. Make sure to consult with business tax attorneys near philadelphia about the best financial decisions for your company.

I’m obviously making some assumptions here on what the standard deduction and exemption amounts will be five years from now. However, the Tax Policy Center has a nice PDF that shows the growth of standarddeductions and exemptionsover the last 15 years, soI’m factoring in growth in those figuresat rates slower than in the past. I’m being conservative. I’m also not factoring in any other possible credits or above-the-line deductions.

My best guess is that any tax liability in retirement as a result of these big conversions will be close to zero. I will have some other income coming in, but that income will be largely offset by for-AGI deductions, I’d have to check with an advisor like Dave Burton just to make sure I am on the right page here.

In Summary

Just to recap the steps, for the first five years of retirement, funds for my living expenses will be limited to current income, passive income generated from my taxable brokerage and original Roth contributions (as they will convert to my taxable brokerage), and principal in the taxable brokerage account.

During the first five or so years of retirement, I’ll convert ~$60k from my traditional IRA to my Roth IRA, owing income taxes (but not really, as discussed) butno penalties.

After five years of retirement, my unencumberedassets increase every year by ~$60k as I withdraw those funds from my Roth and deposit them into my brokerage account. Because I’m adhering to a five-year hold rule, I owe no penalty on the withdrawals even though I’m well under age 59 1/2.

The Bottom Line

There is an often cited number in retirement circles: you need 25xyour yearly net expenses* in investments in order to retire. I agree with that number; it is the basis of the 4% safe withdrawal rule. However, little is said about the disposition of that nestegg. Need it be all taxable and available? Can it be in retirement accounts? What if I retire early?

I’m here to propose a new rule. You still need 25x your yearly net expenses, however, you only need at least 5x in unemcumbered accounts,and 20xin retirement accounts–no matter your age. If you’re above 59 1/2, then all 25x can be in retirement accounts.

Now, please talk to me. What are your thoughts about this strategy?

Thanks so much for reading!

Eric

*:I say “net expenses” referencing the 25x rule because any current income you make (meaning, income generated outside of your investments) will offset any expenses you have, lowering the burden on your investment assets. Hence, the strong power of making a little bit of money during retirement can greatly reduce the amount of assets needed to retire.

**:MadFIentist wrote this postabout this exact same strategy two years ago. It is as applicable as it is today. I only found it a couple weeks after originally publishing this post, so I’m linking to it down here.

Withdraw Your Retirement Accounts In Your 30s. No Taxes. No Penalties. - Retire29 (2024)

FAQs

How much can you withdraw from retirement account without penalty? ›

Emergency personal expense: Each person may withdraw up to $1,000 each year for personal or family emergency expenses. Equal payments: You can take penalty-free withdrawals if you take a series of substantially equal payments, which we'll discuss more later.

How can I withdraw money from my retirement account without taxes? ›

One of the easiest ways to lower the amount of taxes you have to pay on 401(k) withdrawals is to convert to a Roth IRA or Roth 401(k). Withdrawals from Roth accounts are not taxed.

At what age is 401k withdrawal tax-free? ›

As a general rule, if you withdraw funds before age 59 ½, you'll trigger an IRS tax penalty of 10%. The good news is that there's a way to take your distributions a few years early without incurring this penalty. This is known as the rule of 55.

How do I avoid 10% penalty on early 401k withdrawal? ›

Certain medical expenses, disability and various life events may exempt you from the 401(k) early withdrawal penalty. Having an emergency fund or taking a 401(k) loan are other strategies for avoiding the early withdrawal penalty.

How do I avoid 20% tax on my 401k withdrawal? ›

Deferring Social Security payments, rolling over old 401(k)s, setting up IRAs to avoid the mandatory 20% federal income tax, and keeping your capital gains taxes low are among the best strategies for reducing taxes on your 401(k) withdrawal.

How much will I lose if I cash out my retirement? ›

What is the 401(k) early withdrawal penalty? If you withdraw money from your 401(k) before you're 59½, the IRS usually assesses a 10% tax as an early distribution penalty.

Can I withdraw all the money from retirement account? ›

You can withdraw money from your IRA at any time. However, a 10% additional tax generally applies if you withdraw IRA or retirement plan assets before you reach age 59½, unless you qualify for another exception to the tax.

Which states do not tax withdrawals from retirement accounts? ›

Eight states do not impose a personal income tax, meaning retirement income from any source remains untaxed. These states include Alaska, Florida, Nevada, South Dakota, Tennessee, Texas, Washington, and Wyoming.

How do I avoid taxes on retirement payout? ›

Avoid early withdrawals from retirement accounts like IRAs and 401(k)s which carry tax penalties. Consider taking some withdrawals before age 73 to minimize future tax burdens. Roth IRAs offer tax-free withdrawals in retirement and avoid required minimum distributions.

What is hardship withdrawal? ›

Removing funds from your 401(k) before you retire because of an immediate and heavy financial need is called a hardship withdrawal. People do this for many reasons, including: Unexpected medical expenses or treatments that are not covered by insurance.

What happens if I don't file my 401k withdrawal? ›

If you don't take the required minimum distribution, the Internal Revenue Service can assess a penalty of 25% of the amount not distributed. The penalty may be reduced to 10% if you take a corrective distribution and meet other requirements. You can withdraw more than the minimum from your 401(k) plan.

How much income tax will I pay for 401k withdrawal? ›

No income tax is due on withdrawals. However, contributions to traditional 401(k) accounts are made with pre-tax dollars. This means that any withdrawn funds must be included in your gross income for the year when the distribution is taken.

Can I close my 401k and take the money? ›

The IRS allows individuals to cash out their 401k and roll it over to an IRA without penalty and without the cashed-out amount being subject to taxation. You can also close out a 401k without penalty when you leave your job if you are at least 55 years old, but taxes will apply to the amount you withdraw.

Should I cash out my 401k to pay off debt? ›

The short answer: It depends. If debt causes daily stress, you may consider drastic debt payoff plans. Knowing that early withdrawal from your 401(k) could cost you in extra taxes and fees, it's important to assess your financial situation and run some calculations first.

How much can you withdraw from a 401k without penalty? ›

The Internal Revenue Service (IRS) allows some penalty-free early 401(k) withdrawals, including those for unreimbursed medical expenses up to 7.5% of your adjusted gross income (AGI), disability, terminal illness and if you lose or leave your job when you're age 55 or older.

How much can you withdraw in retirement and not run out of money? ›

The 4% rule says people should withdraw 4% of their retirement funds in the first year after retiring and take that dollar amount, adjusted for inflation, every year after. The rule seeks to establish a steady and safe income stream that will meet a retiree's current and future financial needs.

At what age can I withdraw from my IRA without paying taxes? ›

Generally, early withdrawal from an Individual Retirement Account (IRA) prior to age 59½ is subject to being included in gross income plus a 10 percent additional tax penalty. There are exceptions to the 10 percent penalty, such as using IRA funds to pay your medical insurance premium after a job loss.

How much can I withdraw from my retirement account after 65? ›

If you are born in 1958 and after, when you turn 65, you can withdraw an additional amount of up to 20% of your retirement savings.

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