How can I avoid the 10% early retirement withdrawal as a public safety employee retiring before age 50?
I'm a public safety employee and will retire prior to my 50th birthday. How can I rollover my lump-sum distribution and withdraw at age 50 to avoid the 10% early withdrawal?
You didn't say what you plan to do with your career when you are 50. Do you have enough savings to last for another 50 years? If so, then you are permitted to write a letter to the IRS announcing that you are annuitizing your retirement accounts. You can then make withdrawals from your retirement accounts annually based upon a schedule provided by the IRS for this purpose, and there is no 10% penalty for early withdrawal.
However, unless you have millions of dollars saved, it is probably more realistic to transfer (not rollover!) your retirement account into two IRA accounts: the before-tax money to be transferred into a traditional IRA account, and the after-tax money into a Roth IRA account. Do not withdraw any money from these accounts for at least a decade after you retire from your current job; get some other job which allows you to pay all necessary bills without going into debt.
If you don't work when you're in your 50s then it will be even harder afterward to get into the habit of doing so.
Congrats on the early retirement! But I would make sure tapping your retirement funds is the best course of action.
If you have to access the funds, then a direct transfer (the check is never made out to you - made out to the custodian FBO you) from your employer-sponsored plan to an IRA and then enrolling in a SEPP, may be your best course of action:
DEFINITION of 'Substantially Equal Periodic Payment - SEPP'
A plan that allows individuals who have invested in an IRA or another qualified retirement plan to withdraw funds prior to the age of 59.5 and avoid income tax and early-withdrawal penalties. Typically, an individual who removes assets from a plan prior to age 59.5 will face taxes on any income generated by the fund - interest income or capital gain - and will also be subject to a 10% penalty. With substantially equal periodic payments, the funds are placed into an SEPP plan that pays the individual annual distributions for five years or until he or she turns 59.5, whichever comes last.
Because the rules are so strict, SEPPs are often not a good option for those retiring early.
It is possible that your job may allow you to take the funds due to seperation from service (very bottom of chart). Some public service plans allow distributions after age 50 and seperation from service:
I hope this helps. Please make sure you have planned out income, inflation, and healthcare before taking such a big step.
Mark Struthers CFA, CFP®
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This is for informational purposes only. Your specific situation would need to be taken into account. All information is subject to change. Not to be considered investment, tax, or legal advice.
There are exceptions to the 10% IRS early withdrawal penalty and that includes when an employee separates from service during or after the year the employee reaches age 55 (age 50 for public safety employees of a state, or political subdivision of a state, in a governmental defined benefit plan). This exception applies to 401(k) retirement plans only.
Qualified public safety employees: Effective for distributions after December 31, 2015, the exception for pubic safety employees who are age 50 or over is expanded to include specified federal law enforcement officers, customs and border protection officers, federal firefighters and air traffic controllers. Also, the restriction that only defined benefit plans qualify for the exemption is eliminated. Thus, an exemption is allowed for distributions from defined contribution plans or other types of governmental plans, such as the TSP. As amended by the Defending Public Safety Employees’ Retirement Act.
For more details, please see attached article:
How to Avoid the 10% IRA Early Withdrawal Penalty
Rebecca Dawson May 30, 2017
86% of people found this article helpful
Have you ever wondered how you could get money out of your traditional IRA pre-59.5 years of age without paying the 10% early withdrawal penalty? There is a little known section of the IRS tax code: Section 72t that allows you to take substantially equal periodic payments (SEPP) on an annual basis before the age of 59.5 without paying the 10% early withdrawal penalty. The IRS stipulates you take money out of your IRA for five years or until the age of 59.5, whichever is longer.
According to the IRS, funds contributed to investment vehicles such as IRAs or non-qualified annuities are locked into the investment until the money matures. Money in these accounts mature when the investor turns 59.5 years of age. Any and all funds taken out of these accounts prior to 59.5 are subject to a 10% early withdrawal penalty fee in addition to any income tax incurred by the withdrawal. Section 72t essentially allows investors to forgo the 10% fee by making SEPPs.
This allows investors access to those dollars for many differing personal financial reasons and mitigates the size of their traditional IRA, thereby decreasing their RMD (required minimum distribution) after age 70.5.
Keep in mind that any distributions coming out of your traditional IRA will count as provisional income, possibly increasing the likelihood your Social Security may be taxed, contrary to Roth IRAs, which have no taxation from distributions and are free from federal, state and capital gains tax as long as you are over 59.5 years of age. Roth IRAs also have no Social Security tax. Roth IRA distributions do not count against income thresholds that may cause Social Security benefits to be taxed.
Set up SEPPs Before Retirement
In order to calculate the proper balance when taking advantage of the 72t you may need to act before retirement. By postponing until retirement you may risk tax rates being higher than they are today. And you may find you have to shift larger amounts of money because your assets by that time will have grown and compounded.
When you shift assets during retirement, the additional provisional income causes your Social Security to be taxed.
The amount you can withdraw by way of a 72t fluctuates based on a number of criteria, including the age of the account holder and interest rates. All of your future payments will be exactly the same until the SEPP is no longer in effect. It is important to know the amounts you have calculated will be the exact figures for your payments from the account. You cannot name your own amount to take each year.
How to Raise or Lower SEPP Amount
The way to impact the amount of the payment is to adjust the balance in the IRA. If you have more than one IRA available, you can transfer funds into one account to increase or decrease your payment. This must be done before establishing the SEPP. You cannot deposit money into or remove funds from your IRA while the SEPP is in place other than the required payments from the account each year. Any deviation from the prescribed payments will cause the SEPP to be canceled which can result in negative consequences.
Exceptions to the 10% Early Withdrawal Penalty
The following are specific circumstances that will allow exceptions to the 10% penalty under IRS Section 72t:
- Age 59.5
- Upon death paid to the beneficiaries
- Series of substantially equal periodic payments (SEPP)
- Certain qualified medical expenses
- Health insurance premiums
- Qualified higher education expenses
- First-time home purchase
- Seperation from service exception only for 401(k)s not IRAs.
Unfortunately there is absolutely no way you can withdraw funds in a retirement plan unless you have economic hardship you can prove to the IRS. You are in very dicey territory if you are considering doing this. Can I ask why you want to do this withdrawl so early? You are planning to stop working before age 50? Check the IRS website, there is lots of details on the types of tax penalties you will incur. I've included a link for you as a starting point. I would also strongly suggest you talk to an accountant about this before you do anything so they can help you see in black and white the big tax hit you're going to take. https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-hardship-distributions
You can rollover your lump-sum distribution to IRA. Once in the IRA, you can apply for Substantially Equal Periodic Payment withdrawal. The process will allow you to take 5 or more substantially equal annual withdrawals from your IRA. The minimum period is 5 years, but you can extend until you reach 59 1/2. The process has its caveats. If you cancel it before the 5th year, you will have to pay the penalties that you avoided earlier.
However, since you are planning to retire early, make sure that you don't deplete your lump-sum too soon. Unless you are planning to go back to work, you will need enough income to support yourself and your family for the years to come, until you are eligible for social security benefits.
You can read more about it here:
I think it could be beneficial for you to speak with a financial planner who can review your situation in mode detail.