Can You Take Qualified Plan Distributions Before Age 59 ½?

Have you used qualified plans like IRAs, 401(k) accounts, annuities and more to save for retirement? You’re not alone. These accounts are popular because they allow you to accumulate assets without paying taxes on the growth. In most cases, you avoid taxes until you take distributions. In the case of a Roth IRA, you may never pay taxes on your growth or distributions.

Of course, there’s a catch to this tax-favored treatment. The accounts are tax-deferred because they are meant to be used as retirement savings vehicles. That means you can’t take distributions before retirement age, which the IRS has designated as 59 ½. If you take distributions prior to age 59½, you may face a 10 percent early distribution penalty.

This could be problematic if you retire early. Even if you don’t plan on retiring early, you could be forced into retirement before age 59 ½. You could become disabled or suffer some other medical issue. You could be laid off and unable to find a new role. There are a number of reasons why you could retire before age 59 ½.

No matter the reason, early retirement presents a few challenges. One of the biggest is generating income from your qualified plans without paying early distribution penalties. Fortunately, there are a few strategies to help you accomplish this objective. Below are four steps to consider to create income in the early years of your early retirement:

Early Distribution Penalty Exceptions

Typically, all distributions from a qualified account before age 59 ½ are subject to a 10 percent penalty. However, the IRS does allow for some exceptions to the early distribution penalty. Your eligibility for these exceptions depends on the type of qualified plan and the reason for the distribution.

For example, if you need the distributions because of a disability, you could be exempt from the penalty. Your penalties could also be waived if you are using the money to pay for higher education costs, home purchases or even medical bills.¹ A financial professional can help you determine whether your distributions would be eligible for penalty exceptions.

401(k) Distributions Under the Rule of 55

The IRS also offers an exception known as the Rule of 55 specifically for 401(k) plans. It allows plan participants to take penalty-free distributions from a 401(k) plan if they separate from service from their employer in the year they turn 55 or later.

Keep in mind, this strategy applies only to the 401(k) plan for the employer from which you separate from service. For example, you couldn’t use this rule to take penalty-free distributions from an IRA or a 401(k) plan from another employer.

Roth IRA Contribution Withdrawals

Do you have a sizable amount of retirement assets in a Roth IRA? Roth IRAs are popular because they’re not only tax-deferred, but actually tax-free if you wait until after age 59 ½ to take withdrawals. After that age, there are no taxes on your Roth IRA distributions, allowing you to create a tax-free income stream in retirement.

However, Roth IRAs also offer flexibility with early distributions. Since your Roth contributions are made with after-tax dollars, you are always allowed to withdraw your contributions tax-free and penalty-free at any time. The withdrawal of contributions could impact your future growth in the account, but this could be a strategy to consider if you have no other options.

Life Insurance Loan Distributions

One unique strategy is to use life insurance cash value to create income. If you have a permanent life insurance policy that has a substantial amount of cash value, you may be able to use those funds to create income before age 59½.

You can start by taking tax-free loans from the life insurance policy. Technically, these distributions aren’t taxed because they represent a loan that has to be repaid. If you don’t repay the loan, the balance is deducted from the policy’s death benefit after you pass away.

Ready to plan a strategy for your early retirement income? Let’s talk about it. Contact us today at WMS Group. We can help you analyze your needs and develop a strategy. Let’s connect today and start the conversation.

¹https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-tax-on-early-distributions

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