4 Ways to Tap Your Retirement Money Early

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Qualified retirement accounts can offer great tax advantages for people saving for retirement. Those advantages work incredibly well if you use them to save for several decades and then retire at age 59 1/2 or later, but if you need to tap your money early, the benefits can evaporate. For instance, while qualifying Roth IRA withdrawals are completely tax-free, early withdrawals of earnings from a Roth IRA can result in both taxes and penalties on those withdrawals. 

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Still, there are strategies you can use to tap into your retirement money before age 59 1/2. These four techniques will let you tap your retirement money early, gaining access to your cash if you need it before that traditional age.

No. 1: Separate from your employer at age 55 or later

While the standard age to tap retirement accounts without penalty is age 59 1/2, there's an exception if you separate from service from your employer in the year you turn 55 or later. If you do, you can take withdrawals from your employer-sponsored retirement plan without facing the early withdrawal penalty. If you are able to take advantage of that rule, there are three key things to know.

First, the ability to tap that money early without penalty works only for employer-sponsored plans. If you roll the money into your IRA first, you lose that benefit. Second, if you've worked for more than one employer, it applies only to the specific plans of any employer you separated from in that year you reached age 55 or later. Third, the age 55 rule applies only to the early withdrawal penalty, not to any taxes you might otherwise face.

No. 2: Take substantially equal periodic payments

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Another way to take money from your retirement accounts before age 59 1/2 is to set up a withdrawal plan from your retirement accounts known as a "Substantially Equal Periodic Payments" (SEPP) plan.  The primary advantage of these plans is that you can set them up well before a traditional retirement age to avoid the 10% penalty on early withdrawals. The key disadvantage is that once you start one, you must continue it for at least five years or until you turn 59 1/2, whichever is longer.  

That combination of factors makes the SEPP program attractive for people with significant amounts of money in their traditional retirement accounts who want to retire really early. It does add risk to those who are just looking for a short term infusion of cash to tide themselves over through a temporary period of unemployment. If you start a SEPP plan and then later get a job, you're still tied to the SEPP until the last of five years or age 59 1/2 comes around, even if you no longer need the money.

If you do set up a SEPP plan, you have three payment plans to choose from:

  • Required Minimum Distribution: Under this method, you start taking withdrawals as if you were subject to the required minimum distribution rules that generally start at age 70 1/2. Your withdrawals will change each year based on your advancing age and the balance in your account, and it generally results in the lowest annual distribution.
  • Fixed Amortization Method: Under this method, you calculate a fixed annual payment based on amortizing your account balance at the start of the plan, your or your beneficiaries' life expectancies, and prevailing interest rates.
  • Fixed Annuitization Method: Under this method, you calculate a fixed annual payment based on if you were annuitizing your retirement account balance, using your life expectancy and prevailing interest rates.

The second and third methods generally result in higher payments in the beginning of the SEPP, though the Required Minimum Distribution method can get higher if your account balance increases. If you choose the Fixed Amortization or Fixed Annuitization method and later decide that you're at risk of prematurely depleting your account, you're allowed to switch to the Required Minimum Distribution method. 

No. 3: Tap your Roth IRA Contributions

If you're able to plan ahead for an early retirement, your Roth IRA can be an incredibly flexible source of funding for you. Money you directly contribute to your Roth IRA can be withdrawn at any time for any reason, without tax or penalty. Money you get into your Roth IRA through a rollover or conversion from another retirement account can be tapped penalty-free after it's been in the plan for at least five years.  These rules only hold true for your contributions -- not any growth that money may see.

The flexibility comes from the fact that you can take any amount out of your Roth IRA up to the total you've contributed that qualifies for the penalty free withdrawal. So if you don't need the money, you can let it keep compounding for you, penalty and potentially tax free. The downside is that if you're going to rely on converted contributions for a long term early retirement, you'll need to start converting at least five years in advance to get at the money penalty free.

No. 4: Just accept the 10% penalty

If none of the other three methods appeal to you, you can always just take the money directly out of your retirement accounts early and pay the 10% federal penalty on top of any income taxes you owe. If the money you need to tap from your retirement accounts early is small enough -- such as to cover for short-term job loss instead of for early retirement -- it may be the lesser of evils to just pay the penalty.

While it's not ideal to pay Uncle Sam any more than you absolutely have to, it may ultimately be a lower-cost option when compared to a plan that may trap you into withdrawals over several years.

Plan ahead to rule your early retirement

Regardless of the method you choose, each and every one of these approaches requires you to have money in your retirement accounts in order to withdraw it. The more you plan ahead for your retirement, the more you'll likely have in those accounts, and the easier it will be to have enough in the plan to cover the costs of an early retirement. So get started now, and improve your chances of being able to start the retirement you're looking for earlier than you otherwise might have.

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Chuck Saletta has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.