How to get that retirement money early, before 59½
The ‘don’t blame me’ blurb: I am not a financial advisor, portfolio manager, or accountant. This is not tax or investment advice; it’s information to get you going. Please consult your trusty professional and do your due diligence. Carry-on!
When you realize you can get your retirement moolah early. Photo: Kar-Ti
TL;DR
Two methods to avoid the 10% early withdrawal penalty and access your retirement account funds before the standard withdrawal age of 59½.
The IRS rules that make it possible are known as ‘Rule 72(t)’ and ‘The Rule of 55’.
Why this matters now: Planning an early retirement? You can invest using tax-saving retirement accounts, knowing you CAN access the funds later if you want to retire early, rather than using a taxable brokerage account.
Distributions are taxed as normal income.
You can continue working full-time or part-time, depending on which rule you use.
Talk to a good accountant or CFP. Do not wing this one.
Staffers, you can use these rules too.
But! — be aware that pulling money early hampers the magic of compound interest. Make sure you can afford to do it.
Most of us aren't retiring before 59½ — that's just the age the IRS picked for "you're allowed to have your own money now." If you're thinking about an early exit or a slower gear, you might assume that your 401(k), Solo 401(k), or IRA money is off-limits until then.
It’s not; it's just fenced in by rules — and there are two often-not-mentioned IRS rules that could allow you to start using the money earlier.
There is a chance your accountant may not have let you know about these two gems:
The Rule 72(t) - periodic withdrawals
The Rule of 55
Why is it important to know now?
If you make early withdrawals from retirement accounts, you get hit with a 10% penalty. Using these rules avoids that.
Knowing that you can access your retirement funds before 59½ could affect your life planning and investment decisions now.
Common advice for those aiming for early retirement is to invest in a taxable brokerage account, as the funds are accessible at any time. However, not using tax-advantaged accounts like the Solo 401(k), Roth Solo 401(k), and Backdoor Roth IRA could mean missing out on significant tax benefits, depending on your situation.
For example, if you’re a high-income earner, your marginal tax rate is probably 32% or even 35%. Contributing to a Solo 401(k) can help avoid paying those tax rates in your prime earning years.
Don’t get me wrong: taxable brokerage accounts are great (I use one), as you’ll most likely only pay 15% capital gains tax on any profits (and maybe also the 3.8% NIIT). This is a much lower rate than your income tax rate. Just know you have options.
Read about your income tax rates and how they actually work here.
Before you think about using one of these IRS-approved methods, you should consult with a knowledgeable accountant (not all accountants are the same; some just want to file your taxes) or a CFP to make sure you don’t miss something and have the IRS chase you down John Wick style like you shot their dog.
This article is a starting place, so you are aware of your options and can discuss them further with a pro.
Do you really want the IRS eyeballing you if you mess this up? Talk to a good accountant or CFP.
‘Rule 72(t)’ — Periodic Payment Plan.
This rule lets you withdraw funds from an IRA before the age of 59½ using Substantially Equal Periodic Payments (SEPP), provided you keep the rules below in mind. The IRS calls them ‘payments’.
The name “Rule 72(t)” is a street name, not an IRS designation, because it is in section 72(t) of the tax code.
The plan must run for at least 5 years or until you reach age 59½, whichever is longer. Example: You can start the plan at age 50, but it must run until you are 59½.
The plan, once started, cannot be stopped and can be altered only under very limited circumstances without penalty — exceptions to this penalty are death or disability of the account owner and a one-time change to the RMD method.
One of three methods is used to calculate the payment amount; a plan is created to withdraw funds annually, monthly, or quarterly.
RMD method — lowest payment, simplest, recalculated each year.
Fixed amortization — can produce a higher payment, and stays fixed.
Fixed annuitization — can produce a higher payment, and stays fixed.
This sets the maximum amount you can withdraw from the account on the payment schedule you set. Fidelity has a handy calculator here that you can use.
A plan can access funds from only one IRA. But you can have multiple SEPP plans. Example: Two IRAs, two 72(t) SEPP plans.
You cannot add any funds to the IRA once the plan has started.
You can continue to work while using a SEPP, as long as you are taking payments from an IRA.
Consider moving the amount needed for the 72(t) withdrawal plan by taking an ‘in-service distribution’ from your Solo 401(k) to an IRA. Your Solo 401(k) plan must allow in-service distributions. If your Solo 401(k) does not, consider starting a new Solo 401(k) that allows them and rolling your funds into it first.
The payments are taxed as ordinary income, even those from a Roth Solo 401(k). The reason is that Roth accounts only become tax-free at age 59½.
IRS Tax Code 72(t)(2)(A)(iv)
“part of a series of substantially equal periodic payments (not less frequently than annually) made for the life (or life expectancy) of the employee or the joint lives (or joint life expectancies) of such employee and his designated beneficiary,”
‘The Rule of 55’ — it probably works for solo operators
I know that’s not the most encouraging headline. Hear me out.
The Rule of 55 was designed for staffers with a regular job. ‘The Rule of 55’ is simple: If you leave your employer on or after the year you turn 55, you can begin taking withdrawals from your final employer’s 401(k). You cannot withdraw from your other retirement accounts using this rule.
However, the rule should apply to freelancers and single-person businesses if you wind down your own company. The problem is that the IRS does not specify how it would work with a Solo 401(k), where you are both the employee and the employer.
The IRS will sometimes offer ‘guidance’ on a rule or something called a ‘Private Letter Ruling’, but with The Rule of 55, it’s been crickets.
The IRS has not said yes, nor has it said no.
The rule:
The Rule of 55 cannot be used with an IRA or SEP-IRA.
You can use funds only from the last employer’s 401(k). In our case, that would be your freelance biz’s Solo 401(k). Consider rolling other retirement accounts into your Solo 401(k) before you kick off the Rule of 55. If you only have a SEP-IRA, consider rolling it into a Solo 401(k).
You can take a part-time job later and still keep withdrawing from your Solo 401(k).
The ‘Rule of 55’ is a street name for IRS Rule §72(t)(2)(A)(v). I am putting the link here so you can show it to your accountant. If you’re a masochist, feel free to read it. Search for: “(v) made to an employee after separation from service after attainment of age 55”
The catch is what "separate from service" actually means when you are the company. It's not going part-time or rebranding. For a one-person business, it realistically means winding down the business, handing it off to someone else, and stepping away for real.
Here is an IRS note clarifying the above 72(t) rule is IRS Topic No. 558
“There are certain exceptions to this 10% additional tax. The exceptions below apply to distributions from a qualified plan other than an IRA:
Distributions made to you after you separated from service with your employer after attainment of age 55.”
Things to consider with the Rule of 55
Before taking advantage of the Rule of 55, there are several factors to keep in mind.
There's no IRS guidance squarely on the self-employed with Solo 401(k)s. The rule was built for big plans with W-2 staff, so keep your separation genuine and be ready to defend it. Have your accountant read the article here regarding the justification for us self-employed.
The Rule of 55 may be easier to justify to the IRS for S-Corps than for sole proprietors. With an S-Corp, you are literally a W-2 employee of your company. (Note: for those who are an LLC — That is a state business structure, not an IRS classification. The IRS considers you either a Sole Proprietor, Partnership, S-Corp, or C-Corp. You can be a sole trader AND an LLC, for example.
Your Solo 401(k) plan rules: The plan must allow you to take money out upon separation before 59½, and it must allow you to take it in installments rather than require a single lump sum. Many plans do not offer partial withdrawals once you’ve left your job. If your plan does not, you could start a new Solo 401(k) plan with a different provider and roll over your funds. Read the plan adoption agreement that you filled out when you opened the Solo 401(k). You can get custom Solo 401(k) plans from providers like My Solo 401(k) that work with Schwab, Fidelity, and others.
Roth 401(k) tax considerations: Under the Rule of 55, the 10% penalty is waived, but Roth 401(k) earnings are still subject to income tax — because you haven't yet hit age 59½, it's not a 'qualified distribution' regardless of the 5-year rule. Your after-tax contributions always come out tax-free. Talk to your accountant about the pro-rata math.
So which one fits you?
Want early cash but plan to keep freelancing, or you're under 55? Use the Rule of 72(t) on a rolled-over IRA. No shutting down required, works at any age, and the rule is unambiguous for freelancers and the self-employed.
Genuinely retiring or handing off the business at 55+? Rule of 55 — roll qualifying retirement accounts (SEP-IRAs, 401(k)s from former employers) into your Solo 401(k) first to supercharge it. Be aware that there is ambiguity here about how it applies to freelancers and the self-employed with a Solo 401(k).
The bottom line
Both of these are options and available to you even as a party of one.
However, every dollar you pull early stops the magic of compound interest from growing your investments. Only consider the above if you have saved and invested enough money to fund your retirement, chill-out years. Read the post here on how much you’ll need for retirement.
If you’re curious to see how long your money will last, consider using an online DIY planner like Boldin. I use it; it’s pretty amazing for $12/month. Better yet, see a fee-only CFP. They specialize in creating retirement spending plans. Personally, I would not use an advisor who charges an annual percentage, known as AUM. Read about the real cost of those guys here.
I know I am repeating myself, but this is not tax advice; it’s education only.
Did you talk to your professional? Let us know what they said in the comments below.
Sources:
There are no affiliate links in this article. That’s right, no mollah for me. I’m doing this just for the karma.
