Early Retirement Distribution Options

Most people who have retirement accounts realize the importance of leaving these assets untouched until retirement age. Even if they don’t, the government enforces a number of rules and penalties to discourage withdrawals before age 59½.

If you want to retire before age 59½ and begin taking distributions from your 401k plan, you will generally be subject to a 10% early distribution penalty. The early distribution penalty is the cornerstone of the government's campaign to discourage us from plundering our savings before our golden years.

Luckily, there are a couple of ways to do this without paying the 10% penalty.

Leaving Your Job On or After Age 55

The age 59½ distribution rule says any 401k participant may begin to withdraw money from his or her plan after reaching the age of 59½ without having to pay a 10 percent early withdrawal penalty.

There is an exception to that rule, however, which allows an employee who retire, quit or are fired at age 55 to withdraw without penalty from their 401k.

There are two key points early retirees need to know. First, this exception applies if you leave your job at any time during the calendar year in which you turn 55, or later, according to IRS Publication 575.

Second, you can only take money from the 401k plan of your last employer. That means if you left money in the plan of a former employer, you'll have to wait until age 59½ to start taking withdrawals without penalty. Better yet, get any old 401k's rolled into your current 401k before you retire so that you will have access to these funds penalty free.

Substantially Equal Periodic Payments

The substantially equal periodic payment exception is available to anyone with a 401k plan, regardless of age, which makes it an attractive escape hatch. It is called a Section 72(t) distribution. In a 72(t) withdrawal, the distributions must be "substantially equal" payments based upon your life expectancy. Once the distributions begin, they must continue for a period of five years or until you reach age 59½, which ever is longest. The full rules and life expectancy tables can be found in IRS Publication 590. This option generally give you the least retirement pay out available.

Keep in mind that if you use too high a rate of withdrawal, you could run out of money, even before the 72(t) distribution ends, particularly if your investments decline in value substantially.

Final Comments

These two exceptions are only relevant if you are younger than 59 1/2, since there is no penalty for withdrawals over this age.