Friday, February 8, 2008

401k withdrawal at 59 1/2

Getting ready to retire? Many would like to retire as soon as they can begin receiving retirement income without a penalty. You can take a 401k withdrawal at 59 ½ but this has potential problems.

One of the largest hurdles I’ve seen standing between someone wanting to retire and actual retirement is healthcare insurance. Many potential retirees feel their investments are large enough to support them through retirement, if only they didn’t have to pay for their own healthcare between now and age 65, when Medicare kicks in.

You can take a 401k withdrawal at 59 ½ years old without penalty, but unless your employer will pay for your healthcare after retirement, you still have 5 ½ years to pay for it yourself. This is a long scary gap. At this age, you’re not a spring chicken anymore and a major illness can run into the hundreds of thousands of dollars. This is why most feel they can’t scrimp on health coverage at this age. You would really need a much larger 401k balance in order to fund these extra years.

The second largest hurdle is Social Security. Although you can take a 401k withdrawal at 59 ½ years old, you still don’t receive any Social Security payments until you’re at least 62. Again, unless your company has a special program (very few do) you will have to take extra income from your 401k to make up for what you aren’t yet getting from Social Security. This is a 2 ½ year gap. This, again, requires your 401k balance to be larger if you want to retire earlier.

In a perfect world, you have these major issues addressed and don’t need to wait for government programs to kick in before you can retire. Now the question becomes “At what age can I comfortably retire?” Most would assume that since you can take a 401k withdrawal at 59 ½ without penalty that this is the age you can retire. This is correct to a degree, but very incorrect if you are willing to jump through a couple extra governmental hoops.

Within the internal revenue code is a little section called 72(t). If you believe you have a large enough retirement balance to retire prior to reaching age 59 ½, under this section you can begin taking a retirement income without penalty. Again, you must jump through their hoops. You must follow certain guidelines as to how much you have to take and for how long, but at the end of the day, if you have a large enough retirement balance, these rules give plenty of flexibility to begin a comfortable early retirement.

The largest variable to early retirement is the rate of return within your retirement account. You can retire much sooner if your retirement account makes more. How much more and how it is reflected on your retirement age is a topic for another day. If you would like to run some different scenarios for yourself, a very useful retirement age calculator is found here: Retirement Age Calculator
In summary, you can begin receiving retirement income at any age without penalty. You just need to follow the special 72(t) guidelines. Your focus then should be turned to the rate of return you expect for your portfolio in determining a comfortable retirement age.

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