401K and 55 when you retire

[cabb]

Greetings, first post!  I apologize if something like this has already been asked.  Trying to get all my ducks in a row.  There is an IRS rule that says you can avoid the 10% early withdrawal penalty for a 401K currently with your present employer if you retire the year you turn 55 or later.  At 59 1/2, this is a not an issue.  I called my 401K administrator and my company does not allow partial withdrawals from the 401K so it it's an all or nothing proposition.  Therein lies the issue, although the IRS allows it, many company 401K plans do not support it.  I can avoid the 10% penalty, but would need to pay taxes on my entire 401K.  Not good.  I can just to a rollover, but then the 10% early withdrawal penalty is no longer applicable for withdrawals.  I'm 55 and looking for the best strategy to deal with this situation.  My current thought is to take it all out and then put part of it back in an IRA.  This would allow me to avoid the 10% penalty for amount I don't roll over for the first year.  After that I would have to pay the 10% penalty every year.  Any other strategies on avoiding the 10% penalty?  Thanks!

[Fishindude]

I wouldn't touch it till 59-1/2.   Find some other money or another source of income to bridge those few years.
Silly to get in a hurry and take a big penalty.

[RWD]

A SEPP 72(t) might be a viable strategy for that scenario.

[DadJokes]

Do you have anything in a Roth? Or any accounts other than traditional? If so, is it enough to get by for 4.5 years?

If not, a 72(t) is probably your best option. They are pretty rigid, but that's a lot better than pulling out the entire balance and paying taxes on all of it at once or paying the 10% penalty.

[RWTL]

Agree - 72(t) is a potential option. 

Roth conversion ladder is an option if you can survive on other sources of income for the first five years that you can't touch the conversion.  This is also a potential way to minimize taxes.

In some regards, it's not a sin to take the penalty if there is no other option.  Mad Fientist did a nice article about this.  If you use this as a strategy up front, you can minimize the tax burden on the front end and still have a lower total penalty on the back end (e.g. No 24% tax up front, remove at 10% Tax + 10% penalty). Not ideal, but maybe not as much of a sin either.

[terran]

Seek further confirmation before relying on this, but it seems to me you could do a partial indirect rollover whereby you take a full distribution from your 401(k), keep some of it for spending, and put the rest in an IRA. It's not the ideal situation, but it would let you take out something for spending between 55 and 59.5 without paying the 10% penalty. If your spending is low enough you could keep a few years of spending out without going into a terribly high tax bracket. Say around $100k if you're married and stay in the 12% bracket.

Other than that, as others have pointed out you'll need to spend from Roth contributions (but not gains) you've made over the years, taxable, or resort to 72(t).

Edit: Only you can say if this is worth the 10% savings, but another option would be to get a short term job at Starbucks, Home Depot, or somewhere like that just long enough to roll over your 401(k) plan and then quit. Make sure you research the plan of any company you're considering to make sure they have better withdrawal options and acceptable investment options, of course.

[seattlecyclone]

The 72(t) SEPP withdrawals seem like a good option if the amount is high enough to meet your needs. The formulas are rather inflexible and result in a relatively small percentage withdrawal out of the account, but it could work if that amount plus any other unencumbered savings are enough to last you for the five-year minimum SEPP period.

Otherwise I think your idea of doing a rollover with most (but not all) of the money is a reasonable option to consider. You would avoid the 10% early withdrawal tax on whatever amount you choose not to roll into your IRA (which need not be the same as the amount you intend to spend that year).

When exactly do you plan to retire? If it's near the end of a calendar year you'd probably do well to wait until the new year comes around to make the 401(k) withdrawal, so as to avoid combining most of a year's salary in the same year as a taxable retirement withdrawal meant to last you for some time.

[seattlecyclone]

Roth conversion ladder is an option if you can survive on other sources of income for the first five years that you can't touch the conversion.  This is also a potential way to minimize taxes.

Roth conversions don't help someone who is already 55 avoid early withdrawal penalties. By the time the conversion "seasons" they will be old enough to take penalty-free withdrawals directly from their pre-tax IRA.

[cabb]

Wow, a very responsive forum.  Thanks!  The only option I have to get enough money to last 5 years would be a HELOC.  I actually want about 30K of taxable income a year for ACA purposes, so I don't want to go with no income.  I could work to get 30K of income, but that would defeat the FIRE strategy slightly.

[RWTL]

Roth conversion ladder is an option if you can survive on other sources of income for the first five years that you can't touch the conversion.  This is also a potential way to minimize taxes.

Roth conversions don't help someone who is already 55 avoid early withdrawal penalties. By the time the conversion "seasons" they will be old enough to take penalty-free withdrawals directly from their pre-tax IRA.

Very true.  I missed that - Thanks.

[terran]

Taxable income is easy as long as it doesn't need to be spendable. Tax deferred to Roth conversions will count as taxable income to qualify for ACA subsidies, so I wouldn't worry about that as long as you can get enough for your needed spending.

[cabb]

Taxable income is easy as long as it doesn't need to be spendable. Tax deferred to Roth conversions will count as taxable income to qualify for ACA subsidies, so I wouldn't worry about that as long as you can get enough for your needed spending.

It needs to be spendable.  The only way to get to money that would last 5 years would be to use a HELOC, which would cost me prime + .5% in my case.  I would also need to increase the size of my HELOC to get 5 years out of it.  Is leveraging capital built up in a house a good way to avoid the 10%?  Does it make sense to go that route?  We're talking 10% of 30k each year compared to a variable rate the could increase.  In addition, with no paying of the principle, it could become more than $3k per year in the out years of the HELOC as the principal grows.

[cabb]

I ran a calculator to look at the 72t rule.  My current pools of money are 120k roth ira, 50k trad ira, 401k 450k, 50k in savings.  If I rollover the money I end up with about 500k in a traditional IRA.  If I used that online 72t calculator correctly, for a 55 yr old, that's about 25K a year, which gets me close to my goal of 30K a year from ira.  I see that you can stop them at 59 1/2 or 5 years. 

If you begin taking substantially equal periodic payments under rule 72t, you must continue to do so for at least 5 years or until you turn 59 1/2 – whichever is later.

Coincidently I turn 55 this month, so I'd be locked in until 60 if I were to start immediately.

This might be a good way to avoid the 10% penalty and give me some leeway to change my methodology once my roth ira also becomes available.  I just need to make my budget work at about 35K (25k + 10k), so that I could get to 59 1/2, when more options become available, such as using the roth in conjunction with the traditional ira.  My saving would be depleted at that time.  My house is paid off and no car payments either, so it's possible, if I tighten the spending to essentials and there aren't any surprises.  I could use my 75k HELOC as backup in that case.

Thought?  Thanks!

[seattlecyclone]

Remember that the total amount you've ever contributed to your Roth IRA can be freely withdrawn at any age. Only the growth portion (and any amount you've converted from traditional in the past five years) is disadvantageous to withdraw prior to the designated age. The Roth contributions could provide an additional pool of money to help you make it to age 60. That plus the 72(t) distributions and your savings should add up to your $30k target.