Withdrawal Symptoms

[merrell33]

So I'm still in the infant stage of learning about early retirement.  One of the things that I just wanted to ask outright is the topic of withdrawing from retirement accounts such as a 401k.  I'm sure you guys are sick of answering these idiot questions, but how do you withdraw without massive penalties if you haven't met the age requirements?

[foobar]

Roth rollovers or 72(t)

[Nothlit]

You can roll your 401k over to a Traditional IRA, then slowly convert that Traditional IRA balance over to a Roth IRA a little bit at a time every year. If you are able to keep those conversions below a certain threshold, you won't have to pay taxes on them. Each year's conversion needs to remain in the Roth IRA for 5 years, at which point you can withdraw it completely tax free. Some people refer to this as a "Roth IRA pipeline" or "Roth IRA conversion ladder" so you might find more specific details by searching that term.

Another way is by using 72t/SEPP withdrawals. This is an exception in the tax code that allows you to withdraw a series of substantially equal periodic payments without penalty. But you have to be careful because if you make an error in your withdrawals, the whole series of withdrawals (including those you've already made) becomes subject to penalties.

A final way is to separate from your employer in the year you turn 55. That's not really an early retirement by Mustachian standards, but may be beneficial for some people.

[skyrefuge]

how do you withdraw without massive penalties if you haven't met the age requirements?

I'm using your post as a jumping off point for a philosophical tangent, so unless you're already a hardcore dedicated Mustachian, read Nothlit's response again and ignore mine.

I think it's great that most people consider the early-withdrawal penalty to be "massive" and look for (and have found) ways around it. That means they truly consider their tax-deferred savings to be "locked up" and untouchable for non-retirement purposes.

But really, "10%" (the amount of the penalty) is rarely a number that's considered "massive". If you're a prototypical Mustachian (high income, short career, low expenses), your effective tax rate in retirement, even with the 10% penalty, is still likely to be well below the marginal rate during your working career. Example: for a couple with $25k/year expenses, withdrawing ~$28,750 from their tax-sheltered account will leave them with ~$25k after income tax and 10% penalty. That's a 13% effective tax rate.

I guess my point is that even in the extremely unlikely event the IRS was to cut off the 72(t) or Roth pipeline methods, it wouldn't be catastrophic for most Mustachians. It would mean adding another year of work to a 15-year career, or reducing expenses 10% in retirement. And it would still remain advantageous to use tax-deferred vehicles vs. taxable; the advantage just wouldn't be as large as it is currently.  So even if 72(t) or the Roth pipeline didn't exist right now, I think we would still be advising most Mustachians to use tax-deferred vehicles.

[merrell33]

I appreciate the responses without scoffing at my question.  Thanks!  I'm working hard to grow some real stubble and appreciate all the help I can get.  Thank you!