Retiring early on
a 401(k)/IRA without penalty
One of the best ways to have enough money
for retirement is to contribute to your IRA or 401(k) and leave
it alone -- let the money grow. Take advantage of company matching
dollars and deferred taxes and, ideally, if you started the plan
early enough you won't have to find a part-time job asking, "Paper
or plastic?" when you're 70.
But if you want to retire early -- or if you're
seriously strapped for cash and need to tap your retirement money
-- there's a way to do it without triggering a penalty.
For the most part, if you take money out of
an IRA, 401(k) or pension plan before age 59 1/2, you have to pay
a 10 percent penalty on top of ordinary income taxes.
Avoiding the penalty
The exception is if you take the money out in "substantially
equal payments" during your life expectancy. Internal Revenue
Service rules require that you take at least one payment annually
for the exception to apply. Actuarial tables are used to determine
life expectancy and, in essence, you're turning your retirement
plan into an annuity, also called an "annuity distribution,"
or for the truly bureaucratic, "annuitizing an IRA."
Certified public accountant Darryl Hinkle of
Hinkle and Richter in Pompano Beach, Fla., says he's seen very few
people take advantage of this -- and for good reason.
"Say a 35-year-old guy has $100,000 in
an IRA. He decides to take the money out. He'd have to take it out
over 40 years -- so, he'd take $2,500 a year. This limits the ability
for that money to grow. You have to swallow hard when you go into
one of these things."
Furthermore, if our 35-year-old guy decided
a couple of years later that he didn't need the $2,500 and wanted
to reduce his payments to $2,000, the IRS would slap him with the
10-percent penalty. The rules say you can't change the payment plan
for five years or until you reach age 59 1/2, whichever is greater.
Marriage makes a difference
Of course, there's an exception to that rule, too. If a husband
and wife take the payments out together and one spouse dies before
age 59 1/2 or before they've had the account open for five years,
the surviving spouse can adjust the payments based on his or her
own life expectancy without penalty.
Hinkle says there are circumstances where it
might make sense to take such an annuity distribution on a retirement
"If someone's in their 50s and lost their
job, he might say, 'I've got a half-million dollars here and I need
to tap into it. What the heck, I'll start now.' That's more conceivable."
The annuity distribution can be set up as a
one-life annuity or a two-life annuity for married couples. If it's
a one-life and the person is 55 years old, according to the actuarial
table that person will live an additional 28.6 years. If it's a
two-life, based on the life expectancy of both spouses, the table
says both will have died within 34.4 years. So if you have a $500,000
IRA and you opt for the single-life table you divide $500,000 by
28.6 for an annual payment of $17,482.52. Using the two-life annuity,
you divide $500,000 by 34.4 for an annual payment of $14,534.88.
Be aware there are plenty of other situations
where you can withdraw money from a 401(k) or IRA before age 59
1/2 without penalty. They include disability, buying a home for
the first time and paying medical expenses that are more than 7.5
percent of your adjusted gross income. If you're interested in tapping
your retirement fund early, check with the IRS or your accountant
to see if your situation qualifies you to do so without penalty.
-- Updated: May 4, 2001