Retiring early doesn’t just mean you spend fewer years of your life working. It also means you’ll spend more years in retirement.
In other words, retirement lasts longer than it otherwise would.
So, before you walk away from that paycheck, make sure you have a plan to finance those extra years of retirement. If you are too young to qualify for Social Security or to tap into tax-advantaged retirement accounts without penalty, you will need to find alternative sources of income.
For some people, that income will come from savings built up in taxable accounts. But if you do not have enough stashed away in such accounts to make ends meet, there may be some other overlooked ways to access sources of cash.
Following are some secret sources of income available to many retirees beginning in their 50s or even earlier.
1. Withdrawals from a 401(k) plan using the ‘rule of 55’
In most cases, you must pay a penalty if you tap into retirement savings — such as a 401(k) or individual retirement account (IRA) — prior to the age of 59½. But there are exceptions to this rule.
One of them is the so-called rule of 55.
This rule allows you to withdraw from certain types of retirement accounts — including a 401(k), 403(a) or 403(b) — without paying a 10% penalty fee if one of two conditions applies:
- You lose your job during the calendar year that you turn 55, or any year thereafter.
- You leave your job during the calendar year that you turn 55, or any year thereafter.
You still have to pay taxes on your withdrawals — as you would with any withdrawal from a traditional retirement account beginning at age 59½ — but the early withdrawal penalty does not apply under either of those circumstances.
There are a bunch of caveats. For starters, your plan must be “qualified” for you to use the rule. Also, you can only withdraw from the retirement plan you have with the employer you just left. Money from older plans does not qualify under the rule of 55.
If you are unsure about whether the rule of 55 is an option for you, talk to a tax professional.
2. Withdrawals from a 401(k) plan if you are a public safety employee
The rule of 55 is even better if you are a public safety employee. Workers in these jobs can start tapping their retirement accounts penalty-free five years earlier, beginning in the calendar year they turn 50.
Examples of such professions include:
- Police officers
- Firefighters
- EMTs
- Air traffic controllers
As with the rule of 55, this provision only applies to a worker who “separates from service” in the year they turn 50 or a later year, and only withdrawals from a final employer’s retirement plan will be penalty-free.
Once again, it would be foolhardy to explore this option unless you are absolutely sure you are eligible to do so. Consult with a tax professional before using the strategy.
3. Payments from retirement accounts using SEPPs
Another way to tap your retirement account early — regardless of age — is to withdraw money using substantially equal periodic payments.
Often referred to as SEPPs — or the 72(t) method, which refers to the section of tax code that outlines the rule — these are equal payments that you must take for at least five years or until you turn 59½, whichever is longer.
You can use this option to withdraw from both 401(k) plans and IRAs. However, this approach is not for the faint of heart. Many financial advisors recommend against using the option, warning that the rules are inflexible and it is easy to end up regretting your decision.
Speak with a professional and think long and hard before going in this direction.
4. Strategic withdrawals from an HSA
Tapping into your health savings account can be a great way to gain access to extra income during early retirement. However, this approach works best for those who plan a strategy and begin to execute it years — or even decades — in advance of an early retirement.
Here’s how to do it: Long before early retirement, you make annual contributions to your health savings account. During this period, you never use the money in the HSA to pay for qualified medical expenses, even as you incur such costs.
Instead, you use a taxable account to pay for all medical bills not covered by insurance. Each time you do so, you save and file away the receipt that shows how much you paid.
Then, when retirement arrives and you need some extra money, you dig out those old receipts and start reimbursing yourself by withdrawing money tax-free from your HSA — which, with any luck, has swelled to an enormous size thanks to years of compounding returns.
All of this is completely within the rules for HSA plans as set by the IRS. For more on this strategy, check out “6 Reasons This Is the Best Type of Retirement Account out There.”
5. Contributions to your Roth IRA, regardless of age
When you contribute money to a Roth IRA, you cannot touch the earnings penalty-free until you reach the age of 59½.
However, you can withdraw the contributions at any point. You already have paid taxes on this money, so you are not penalized for withdrawing the cash.
To illustrate: Say you make a single contribution of $6,000 to your Roth IRA. After five years, you have earned an average annual return of 7% on that initial principal. That means you now have $8,415 in the account.
You can withdraw that initial $6,000 at any point penalty-free, regardless of your age. It is the earnings — $2,415 — that are subject to an early withdrawal penalty prior to age 59½.
As with SEPPs, just because you can do something doesn’t necessarily mean you should. Once you start withdrawing from a Roth, that money is no longer able to compound and fatten your nest egg for future years.
But some early retirees might determine that withdrawing that principal early is worthwhile.
6. Withdrawals from any retirement account — if you are willing to pay the penalty
Finally, you can always withdraw funds from a 401(k), IRA or other similar retirement account at any time if you are willing to pay taxes and penalties on the amount you withdraw.
This option can provide you with quick access to cash, especially if you need money fast to pay for an emergency expense or other obligation.
Of course, you pay a tremendous price for the privilege of withdrawing money in this way. The penalty on the withdrawn amount is generally 10%, plus whatever you would pay in regular income taxes, which depends on your tax rate.
That can add up to a hefty chunk of your withdrawal, and for many people, it is unlikely they will be able to make up that lost money in the future.
But this type of withdrawal is an option, and it might make sense as a last resort.
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