The age of 65 has often been viewed as the “traditional” retirement age in the U.S. But there are no laws stating that you have to retire at 65. Most people have the freedom to retire whenever they want, assuming they have the financial means to do so.
This includes retiring early. Many people dream of an early retirement in order to pursue goals that don’t involve working full time, such as traveling, volunteering or participating in hobbies or interests. If this is your goal, there are a few factors you should consider as you plan for an early retirement.
The first, of course, is whether or not you have access to enough money to retire early. This may be in the form of retirement savings accounts, such as an IRA or company-sponsored 401(k) plan, a pension plan at your employer, Social Security, an inheritance or some other source of income.
Making Early Retirement Account Distributions
Retirement savings accounts are the primary source of retirement income for many Americans today. But if you plan to tap into such an account for an early retirement, you should be aware of the rules regarding early distributions from some of these accounts.
Specifically, you may be subject to a 10 percent early withdrawal penalty if you withdraw money from a traditional IRA or 401(k) account before you reach age 59½. This is in addition to ordinary income taxes that will be assessed upon withdrawals. Note that early withdrawals of principal from Roth IRAs that have been open for at least five years are not subject to penalties or taxes because this money has already been taxed.
There are scenarios in which early withdrawals can be made from 401(k) accounts and IRAs without a penalty being assessed. According to the “Rule of 55,” if you participate in a 401(k) plan and are between 55 and 59½ years of age during the year you leave your current job, you may qualify to make penalty-free withdrawals. This rule applies regardless of whether you leave your job voluntarily or are fired or laid off.
And according to the Substantially Equal Periodic Payment (or SEPP) exception, you can make penalty-free early withdrawals from a traditional IRA if you make five substantially equal withdrawals for five years in a row before you turn 59½. This can happen at any age — you don’t have to wait until you’re 55 years old. Note that with both of these exceptions, you will still have to pay ordinary income taxes on the money withdrawn.
Other Sources of Retirement Income
Though many companies have replaced pension plans with 401(k)s and other defined contribution plans, some Americans still have access to a company pension plan. Talk to your human resources department to find out whether your company offers a pension plan and, if it does, how this income could possibly help you retire early.
You should also determine how Social Security could affect your plans to retire early. The earliest you can begin receiving Social Security benefits is age 62. So if you plan to retire before this age, you’ll have to do so without the benefit of Social Security income. And if you retire before you reach your full Social Security retirement age, your benefit payments will be reduced every month for the rest of your life.
Finally, factor any other income sources you might have into your early retirement plans, such as an inheritance or other large lump-sum payment or distribution. If you anticipate receiving any type of income like this at some time in the future, it could provide additional money to help you retire early.
For example, you could possibly use the money to pay off your home mortgage, which could significantly lower your retirement living expenses. Or you could possibly buy an annuity that would provide you with an additional stream of income each month. Talk to your financial advisor about the best ways that such a lump sum could be used to help you retire early.
Plan Carefully and Early
If retiring early is one of your dreams, you may need to plan very carefully well in advance of your desired retirement date to make it happen.
Please contact us if you have more questions about retiring early and how you can devise a plan to make this dream a reality.