My nominal tax rate is 39% now. Later, in retirement, that means my tax rate would have to be at least 29% to overcome the 10% penalty.
I have a rental house which will provide my 'base' income (~20k). Anything above that is hit with at least a 25% tax.
Hennnnnghhhhh?
Single Filing Status
[Tax Rate Schedule X, Internal Revenue Code section 1(c)]
10% on taxable income from $0 to $8,925, plus
15% on taxable income over $8,925 to $36,250, plus
25% on taxable income over $36,250 to $87,850, plus
28% on taxable income over $87,850 to $183,250, plus
33% on taxable income over $183,250 to $398,350, plus
35% on taxable income over $398,350 to $400,000, plus
39.6% on taxable income over $400,000.
Married Filing Jointly or Qualifying Widow(er) Filing Status
[Tax Rate Schedule Y-1, Internal Revenue Code section 1(a)]
10% on taxable income from $0 to $17,850, plus
15% on taxable income over $17,850 to $72,500, plus
25% on taxable income over $72,500 to $146,400, plus
28% on taxable income over $146,400 to $223,050, plus
33% on taxable income over $223,050 to $398,350, plus
35% on taxable income over $398,350 to $450,000, plus
39.6% on taxable income over $450,000.
Married Filing Separately Filing Status
[Tax Rate Schedule Y-2, Internal Revenue Code section 1(d)]
10% on taxable income from $0 to $8,925, plus
15% on taxable income over $8,925 to $36,250, plus
25% on taxable income over $36,250 to $73,200, plus
28% on taxable income over $73,200 to $111,525, plus
33% on taxable income over $111,525 to $199,175, plus
35% on taxable income over $199,175 to $225,000, plus
39.6% on taxable income over $225,000.
Head of Household Filing Status
[Tax Rate Schedule Z, Internal Revenue Code section 1(b)]
10% on taxable income from $0 to $12,750, plus
15% on taxable income over $12,750 to $48,600, plus
25% on taxable income over $48,600 to $125,450, plus
28% on taxable income over $125,450 to $203,150, plus
33% on taxable income over $203,150 to $398,350, plus
35% on taxable income over $398,350 to $425,000, plus
39.6% on taxable income over $425,000.
There isn't any conceivable filing status that taxes 20k of income at 25%. Moreover, our system of taxation is progressive-- only the amount within the range is taxed at that rate, not the whole of your earnings. *Absolute* worst case scenario (Single filing status) you have to hit almost double that income ($36,250) before you get to the 25% bracket.
BTW, you say your tax rate is 39%... so your income is > 400K a year (in which case only the income over 400K is taxed at 39.6%)? If you want your maximum rate of taxation to be under 29%, then all you need to do is get your annual expenses under $73K in the worst case scenario.
Finally, You needn't pay any penalty on 401k income in early retirement. Various strategies outlined here (the most usable of which is the Roth IRA pipeline):
http://www.mrmoneymustache.com/2011/11/11/how-much-is-too-much-in-your-401k/