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Retiring early? Possible ways to tap savings but sidestep penalties

Amy Fontinelle

Posted on August 11, 2023

Amy Fontinelle is a personal finance writer focusing on budgeting, credit cards, mortgages, real estate, investing, and other topics.
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Suggest what kind of funds to use first to avoid an early retirement penalty.

Provide early retirement options to consider depending on your age and what kind of retirement accounts you have.

Look at some of the options available for taking early distributions from your IRA and possibly other retirement accounts.

Your dream of early retirement is on the horizon, and you are not even 50 years old. Very few can consider it at this point. But you have worked hard, saved and invested, and avoided or overcome major financial setbacks. But if all your money is in retirement accounts, you might have a problem accessing the funds you need to retire without paying penalties.

In exchange for the tax advantages that come with retirement accounts such as 401(k)s and traditional IRAs, the IRS expects you to keep the money in your account until you reach your 60s. To discourage you from taking it out early, the tax authorities impose penalties of 10 percent of the taxable portion of retirement plan distributions before age 59 1/2.

These rules have exceptions, though, and if you are planning to retire early, you need to know what those exceptions are as well as where else you might turn for penalty-free cash. Depending on your situation, the decisions can be complicated and many opt to consult a financial professional to help understand the choices.

Use non-qualified funds first

Ideally, anyone retiring early has some funds in a “non-qualified” account, one that doesn’t get the special tax treatment of certain retirement accounts. Depending on the type of assets, they may be able to withdraw these funds at the lower qualified dividend and capital gains tax rates before taking a retirement plan distribution, which will be taxed as ordinary income, said financial planner Kevin Feldman of Feldman Capital, an asset management advisory firm in San Francisco.

Most of the income from brokerage account investments such as mutual funds and exchange-traded funds is taxed as qualified dividends, which for most people have a lower tax rate than ordinary income, Feldman explained. The same is also generally true for long-term capital gains taxes on appreciated investments that you sell. (Related: How to avoid and offset taxes on capital gains)

In fact, if you are in the bottom capital gains tax bracket — with income up to $41,675 for single filers and up to $83,350 for joint married filers for 2022 — you pay no federal tax on your qualified dividends and long-term capital gains. Those figures climb to $44,625 and $89,250 respectively in 2023.

Cash withdrawals from savings are another option, as is selling your home. (Related: Downsizing in retirement: Is it better to rent or to own? )

55 or older? Consider your 401(k) or 403(b)

If you separate from your employer in or after the year when you turn 55, the 10 percent tax on early 401(k) distributions does not apply. The same rules apply to employees from public schools and charitable organizations who have a 403(b) plan.

State and local government employees may also participate in a 457(b) plan. Workers with these plans may take early withdrawals without penalty at any age after separation from service, but they will pay regular income tax on the withdrawals since contributions are made with pretax dollars.

Certain public safety employees who work for a state or a political subdivision of a state who have a governmental defined benefit plan may take penalty-free distributions after separating from service at or after age 50.

While some who separate from service at 55 may wish to roll their 401(k) balance into an IRA to gain more investment choices and greater control, doing this right away if you retire at 55 may not be in your best interest since you can avoid tax penalties by taking distributions from your 401(k). In other words, if you roll 401(k) funds into your IRA, you lose the ability to withdraw funds penalty-free at 55.

Once you reach age 59 1/2 and do not have to worry about early withdrawal penalties anymore, you might want to roll the balance into your IRA, said financial planner Byron Ellis of Goldman Sachs Personal Financial Management in The Woodlands, Texas. Another option is to keep enough money in your 401(k) to cover your expenses up to age 59 1/2 and roll over the balance when you reach 60.

Younger than 55 or no 401(k)? Perhaps your Roth IRA

Any qualified distribution of your funds from a Roth IRA is not considered a taxable distribution, and you do not have to report this money in your gross income when you file your tax return. In order to be a qualified distribution, it must be made after the five-year period beginning with the taxable year in which you first made your contribution to a Roth IRA, and must meet one of the following requirements:

  1. Made on or after the taxpayer turns 59 ½.
  2. Made to a beneficiary or the taxpayer’s estate on or after the death of the taxpayer.
  3. Attributable to the taxpayer being disabled.
  4. It is a “qualified first-time homebuyer distribution, up to a maximum lifetime limit of $10,000.”

Non-qualified distributions of earnings from a Roth, however, are considered income, and if you take them before age 59 1/2, you have to pay a 10 percent penalty on the taxable part of the distribution. The penalty may not apply if you meet a different exception.

Other tax rules may apply to any sums in your Roth IRA that came from a traditional IRA or 401(k) rollover. If a non-qualified distribution includes those funds, the 10 percent penalty will apply, regardless of whether the distribution is otherwise taxable. To avoid this, five years must have passed from the date of the conversion or rollover. Of course, if after-tax contributions to an IRA were rolled over, those funds would not have been taxable at the time of the rollover (since they are already after-tax) and would not be caught up in this rule.

If your Roth account includes both regular contributions and conversion amounts, any distributions are categorized as follows…

The money you withdraw is first allocated to your regular contributions—which is good, because there is no penalty involved. Any conversion or rollover contributions come next. Finally, distributions in excess of any type of contribution are considered to be distributions of earnings, which may be subject to the 10 percent penalty as well as tax. Conversions or rollovers may be subject to the penalty as well, as described above. In determining the taxes and penalties, the IRS aggregates all Roth IRAs. IRS publication 590-B explains the complex rules for Roth IRA distributions.

While it is nice to have the option to take money out of a Roth early without penalty, you lose out on another major benefit of the Roth if you do. Roth balances grow tax free and do not require distributions during your lifetime at any age, which means you have an opportunity to grow your nest egg indefinitely in a way that you do not with a 401(k) or traditional IRA, both of which require you to start taking minimum distributions (RMDs) each year once you turn 73. The age limit for RMDs climbs to 75 on Jan. 1, 2033. You may even leave the Roth account to your heirs if you do not deplete it yourself (although RMDs apply to Roth beneficiaries). (Learn more: Turning 73? Required minimum distributions explained)

Another option before 59 1/2: Substantially equal periodic payments

One option for taking early distributions from a traditional IRA or for taking non-qualified Roth IRA distributions is to use the IRS’s section 72(t)(2) rule, which allows retirement account holders to avoid paying the 10 percent penalty by taking a series of substantially equal periodic payments (SEPPs) for five years or until the account holder reaches age 59 1/2, whichever is longer.

You may also take SEPPs from a qualified plan such as a 401(k) or 403(b) after leaving your employer.

The IRS provides three methods for calculating SEPPs, said Edward Dressel, president of Trust Builders, a company in Dallas, Oregon, that provides retirement planning tools for financial advisors.

One method, the life expectancy method, is based purely on the account owner’s age. The two others, the annuitization and amortization methods, factor in both age (i.e. the first method’s life expectancy element) and a reasonable interest rate. The rate is based on mid-term interest rates, which stood at around 3.7 percent as of March 2023.

The amortization and annuitization methods require the account holder to take an identical distribution amount each year, while under the RMD method, the distribution amount gets recalculated each year based on the account balance as of December 31 of the prior year and the new life expectancy based on the account holder's current age. The same life expectancy table must be used each year.

Dressel provided an example to show how SEPPs would work for a 50-year-old with a $1 million account balance under each of the three calculation methods :

Life expectancy (also called Required Minimum Distribution)

To calculate: Divide the account balance of $1 million by the account holder’s life expectancy using an IRS-approved life expectancy table. Using one of the approved tables (single life expectancy), the life expectancy for a 50-year-old is 34.2 years. Dividing $1 million by 34.2 yields $29,239.77. There would be differing amounts thereafter.


To calculate: The annuitization method calculates an annuity rate from an IRS-provided table that produces a factor based on the current interest rate and the client’s age. Dressel says this calculation is best left to a computer. The account balance is divided by the calculated annuity rate.


To calculate: The inputs you need are your life expectancy factor from one of the IRS-approved tables, an interest rate that is not more than 120 percent of the federal mid-term rate, and your account balance. Create an amortization schedule using an online 72(t) calculator to learn what amount you will need to withdraw each year. The maximum interest rate that can be used as of January 2023 is 4.62 percent which is 120 percent of the federal mid-term rate. The life expectancy is 34.2 based on the single life table and the account balance is $1 million. The calculation at January 2023 rates yields $51,202 annually.

The simplest way to see your options is to use an online 72(t) calculator to project the income that may be generated from a given account balance.

When you take SEPPs from a 401(k), 403(b) or traditional IRA, you pay ordinary income tax on the taxable portion of those distributions, just as you would if you were taking a required minimum distribution or any other type of distribution from these accounts.

There is a major catch to taking SEPPs, however.

“If payments do not occur for the required amount of time, a penalty of 10 percent is applied retroactively to all of the distributions,” Dressel said.

In other words, if you start taking $1,000 a month in SEPPs at age 50 and then at age 54 you stop, you will pay the 10 percent penalty on the $48,000 you’ve withdrawn over the years: a $4,800 penalty, plus interest.

If the SEPP is modified, you will pay a retroactive penalty. For example, if you started working part time and wanted to contribute more to your IRA, you’d incur penalties. Or if you did a rollover. You will also incur penalties if, in addition to taking the planned annual payments, you withdraw a lump sum from your account because you are short on cash. You will pay penalties on the SEPPs you have already withdrawn plus a penalty on the lump sum.

Dressel said that SEPPs might be onerous for someone who simply needs a one-time distribution or who needs more flexibility in how much is distributed each year.

And SEPPs will not generate enough income to live off of based on the typical retirement balance and typical income need, Dressel said. For example, a person retiring at age 59 who wanted to generate an annual income of $75,000 using SEPPs would need an account balance in excess of $1.5 million. Section 72(t)(2) distributions work better if they complement other sources of income, such as part-time work.

When paying the 10 percent penalty might make sense

If your taxable income after deductions and exemptions is zero, then the only tax you will pay on an early withdrawal is the 10 percent penalty, said financial planner Richard E. Reyes of Wealth & Business Planning Group in Maitland, Florida.

Reyes provided a simple and idealized example to illustrate hypothetically, as actual circumstances are likely to be far more complex: For a single 55-year-old who took a $10,000 traditional IRA distribution in 2023, the standard deduction would be $13,850 (assuming no other income sources). Taxable income on the distribution is thus zero, and the penalty on the distribution is $1,000. The same would apply for a single 55-year-old who took a $50,000 traditional IRA distribution and had $50,000 in itemized deductions. The penalty on the distribution is $5,000 (again, assuming no other income sources).

The bottom line

If you retire before age 59 1/2 and you’ve been saving, you likely have several options for funding your retirement without paying the IRS’s dreaded 10 percent penalty on early retirement account distributions. The consequences of making a mistake can be expensive, however, so you may wish to consult a financial professional for help with creating your early retirement income strategy.

Discover more from MassMutual…

How to make sure your heirs won’t fight

Are you in the wealth transfer zone?

The unexpected problems with early retirement

This article was originally published March 2017. It has been updated.


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The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.