Early retirement is no longer an unusual topic.
We have seen young professionals save up a large portion of their pay by living frugally and making wise investment decision so that they can leave their careers before the usual retirement age.
With proper planning and diligence, it is possible to build significant net worth over a relatively short period of time, and the use of alternative investments often increases chances for achieving your early retirement goals.
The problem is that qualified retirement plans, such as 401(k)s and IRAs, were created with the traditional blueprint; you are supposed to leave your money untouched until you reach 59 ½ years old.
This leads to a heated debate over whether traditional retirement accounts are a good idea for those who aspire to retire early.
One common argument against 401(k) and IRA accounts is that an early retiree will need the money before the traditional retirement age and these funds are constrained to traditional investments, such as stocks, bonds and mutual funds.
If a person takes an early distribution from a 401(k) or IRA, a penalty of 10% will apply, minimizing the amount of funds the investor is left with.
In my opinion, the problem with this argument is that it focuses mainly on the period before the person turns 60.
A retirement, early or not, does not simply end at the age of 60. Most people plan to live much longer than that.
Even if you retire in your 40s and wait until you can withdraw from your retirement funds without penalty, your 401(k) contributions can still become a substantial supplement to your taxable investments.
And, with the use of a self-directed IRA or 401(k), the account holder has virtually limitless investment options, including real estate, private businesses, trust deeds, tax liens, cryptocurrency, private lending and more.
Another problem with this argument is that most people assume retirement funds are absolutely untouchable until the retiree is 60 years old.
While restrictions are in place, there are certainly workarounds that can help individuals tap into their retirement funds early.
Below, we will discuss different ways you can gain access to your 401(k) or IRA funds for an early retirement.
How To Access Your Retirement Funds Early
Route I: Paying The Penalty
In most cases, if an account owner makes a withdrawal from his or her retirement funds before the age of 59 ½ years, it will be considered an early withdrawal and result in an additional tax penalty of 10%.
Early retirees may choose to pay the additional 10% tax on the withdrawals. While this sounds like an unorthodox idea to most, this simple solution can still work out.
The money you put into a 401(k) is left to grow on a tax-deferral basis. Over time, the tax benefits can outweigh the penalty.
Said another way, even with the penalty tax factored in, investments within a qualified plan can still outperform taxable investments.
Route II: Substantially Equal Periodic Payments
An exception to the early withdrawal penalty is the Substantially Equal Periodic Payments (SEPP), which can work well for early retirees. With this exception, the IRS allows you to withdraw substantial amounts from your IRA without paying the 10% penalty.
Following this route, a retiree will use one of the three calculation models specified by the IRS to make a substantial withdrawal each year.
You will have to commit to at least five annual withdrawals or continued withdrawals until you turn 59 ½ years old -- whichever occurs later. For example, if you plan to retire at the age of 40 and decided to take SEPP withdrawals, you will need to follow through until you turn 59 ½ years old.
On the other hand, if you start taking SEPP withdrawals at the age of 57, the commitment is extended until you turn 62.
The drawback to this method is that the calculation can get complicated and may require the help of a tax professional. If you fail to withdraw the correct amount every year, the penalty will apply to all the withdrawals up to that point.
The perk, however, is that SEPP allows you to get instant access to your retirement funds without penalty. It also allows you to keep the rest of your funds in a tax-deferred account longer for faster growth.
Route III: Roth IRA
Another penalty-free option is to choose a Roth IRA. The best thing about a Roth IRA is that you can withdraw your contributions any time you want without a penalty.
Keep in mind that you will need to wait five years to withdraw any earnings or any amount converted from a traditional IRA.
