The IRS gives you something to celebrate six months before you enter your sixth decade of life: The option to finally withdraw your retirement savings penalty free happens at age 59½.

At Age 59½ You Can Finally Take Distributions...

You can finally tap your IRA, SIMPLE IRA, SEP, SARSEP, 401(k), 403(b) or other qualified plan without incurring the dreaded 10% early distribution tax. While there are a few exceptions, such as early retirement, that let you withdraw the money penalty free as young as age 55, they don’t apply to many people.

Here’s what you need to know about taking retirement account distributions once you turn 59½.

...But You Don’t Have To 

If you don’t need your retirement funds at age 59½, leave them alone. Distributions aren’t required until April 1 after the year when you turn 70½ for most account types. Roth IRAs never have required minimum distributions (RMDs) during the original account owner’s lifetime; employer-sponsored plans let you postpone RMDs until the year you retire. (For more see How Is Your 401(k) Taxed When You Retire?)

Why keep the money in the account longer than you’re legally required to? Simple. Doing so allows you to keep gaining the benefits of tax-free growth and compound returns. You have 11 more years until RMDs kick in. The table below shows how much your account balance could increase by over those 11 years if you don’t touch it.

Starting Balance, Age 59½

Average Annual Return Before Taxes and Inflation

Years to Grow

Ending Balance, Age 70½

$500,000

4%

11

$776,335

$500,000

6%

11

$967,343

$500,000

8%

11

$1,205,332

The math clearly shows that you have a lot to gain by not touching your retirement account funds until you really need to (or are required to).

Now vs. Later: The Income Tax Consequences

When you’re ready to take distributions, unless your account is a Roth IRA or Roth 401(k), you’ll pay tax on your distributions at ordinary income tax rates. (And be aware of the five-year waiting rule for Roth IRAs.) An exception that doesn’t apply to many people is if you’ve made nondeductible contributions to a traditional IRA. Only distributions of investment gains are taxable for those distributions, as you already paid tax on your contributions, similar to Roth IRA contributions. (For more, see How an IRA Works After Retirement.)

If you’re still working, the income tax rates on your retirement account distributions could be quite high. After you retire, you may be in a lower tax bracket, which means more of your distributions will stay in your own pocket instead of going to pay for your favorite government program.

Some people, however, might save on taxes by beginning retirement account distributions earlier, before Social Security, pension or other retirement payments kick in. You’ll have to weigh the potential income tax savings against the potential loss of tax-free investment growth you’d get from leaving the money in the account. Don’t be afraid to pay a professional for help with these calculations if you aren’t comfortable performing them yourself. For a few hundred dollars you could save thousands. (For more, see How to Minimize Taxes on 401(k) Withdrawals.)

You’ll also have to consider the possibility of future tax rate changes and how those might affect your now-vs.-later distribution decisions. For example, the Trump individual tax rate cuts passed at the end of 2017 expire after 2025, which will increase tax rates for most people unless Congress extends them. A new administration could cut rates further – or increase them beyond 2017 levels. (For more, see Do retirement account withdrawals affect tax brackets?)

Another issue to consider if you’re old enough to claim Social Security retirement benefits is the effect that retirement account withdrawals could have on the taxability of your Social Security benefits. Everyone receives at least 15% of their Social Security benefits tax free. However, people who have other sources of taxable income, including retirement account distributions, may owe tax on as much as the other 85% of their Social Security benefits. For example, if you’re married filing jointly and your taxable income is more than $44,000, you may have to pay taxes on up to 85% of your Social Security benefits.

The Bottom Line

While you can withdraw money from your retirement accounts at age 59½ without paying the 10% early distribution penalty that you’d owe if you were younger, you’ll likely be better off leaving the money alone until you’re older, unless you need it to meet your basic living expenses. Consider working with a financial planner to develop a retirement drawdown strategy that will maximize your investment returns and income and minimize your taxes. (For more, see What’s the Best Retirement Drawdown Strategy for You?)

 

 

Want to learn how to invest?

Get a free 10 week email series that will teach you how to start investing.

Delivered twice a week, straight to your inbox.