Retiring early has its perks, but it has its problems too. Some of the most frustrating are the annual contribution limits and the early withdrawal penalties for those under 59 1/2. Fortunately for 50-somethings, there are some ways around these issues. We’ll look at a few of them below.
1. Catch-up contributions
Adults 50 and older are allowed to make catch-up contributions to their retirement accounts. In 2021, they’re allowed to contribute up to $26,000 to a 401(k), compared to just $19,500 for adults under 50. They can also contribute up to $7,000 to an IRA each year — $1,000 above the limit for adults under 50.
If you’re able to set aside this much money every year, you can grow your retirement savings more quickly and you may be able to leave the workforce sooner than you’d originally planned.
You don’t have to do anything special to take advantage of catch-up contributions. As long as you’ll be 50 or older by the end of the year, you can contribute up to the limits above. Remember, these limits apply to all retirement accounts of the same type. So you’re limited to $7,000 among all of your IRAs for the year, not $7,000 in each.
2. Substantially Equal Periodic Payments (SEPPs)
You may have heard you can’t withdraw money from tax-deferred retirement accounts before 59 1/2 without paying a penalty. This is generally true, but there are some exceptions to that rule. One of them is Substantially Equal Periodic Payments (SEPPs).
This is where you agree to withdraw a certain amount from your retirement every year for at least five years or until you reach 59 1/2, whichever is longer. The exact amount you must withdraw depends on your account balance and which of the three methods you use to calculate your SEPP. See the article linked above for more details.
This method is worth considering if you have the bulk of your savings in tax-deferred retirement accounts and you are pretty sure you have enough savings already to last you the rest of your life. Before you go through with it, do some calculations to figure out how much you plan to withdraw every year for your living expenses and how much you are legally required to take out every year for your SEPP. You must also remember you’ll still owe taxes on your tax-deferred retirement distributions, even if you don’t owe a penalty.
3. The Rule of 55
Adults who will be at least 55 by the end of the year may take penalty-free withdrawals from their 401(k) if they quit their job or are fired or laid off. Qualifying public safety employees, including those who work for the federal or a state government, can actually take advantage of the Rule of 55 the year they turn 50, again assuming they part ways from their employer.
The Rule of 55 only counts toward your retirement account from that particular employer. If you have an IRA or a 401(k) from a former employer, you cannot tap these funds early unless you roll them over into the 401(k) you had through your most recent employer. You’re also still responsible for paying taxes on these funds if they come from a tax-deferred account.
4. Roth retirement savings
Roth retirement withdrawals work a little differently than tax-deferred retirement withdrawals. You pay taxes on your Roth retirement contributions, therefore, you don’t owe any taxes on your withdrawals. This can make them a great place to begin if you plan to retire before you’re 59 1/2. But there are a few rules you need to keep in mind.
You can withdraw your Roth retirement contributions at any time, even before 59 1/2, without penalty, but you will pay a penalty for withdrawing your Roth account earnings before 59 1/2 unless you do so for a qualifying reason, like a first-home purchase or SEPPs.
You will also owe taxes on your earnings if you withdraw them before you’ve had your Roth retirement account for at least five years, even if you’re over 59 1/2 at the time. Find out how much money in your account is personal contributions and how much is earnings, and note how long you’ve had the account before you decide if this is the right approach for you.
You can use one or a combination of these approaches if you’d like to retire early, but make sure you understand the pros and cons before you touch any of your retirement funds. And of course, run the numbers one last time to make sure you have enough savings to last the rest of your retirement before you leave the workforce for good.
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