IRAs And Early Retirement

IRAs And Early Retirement
By Robert D. Cavanaugh, CLU

Dual income families and megabucks 401(k) plans are common
socio-economic trends that get today's Boomers thinking about
early retirement. If you elect to retire early and roll your
401(k) plan into an IRA, how can you best set up a withdrawal
plan?

First, it depends on what kind of IRA you have. The rules
differ for Roth IRAs. Second, it depends on whether you retire
before or after age 59 1/2. For our purposes, we are going to
assume retirement occurs before age 59 1/2.

What Income is Taxable?

The first issue is to be clear on are the rules as to what IRA
withdrawals are taxable income. With traditional IRAs, the
answer is easy: All income is taxable. However, if you made
non-deductible contributions to a traditional IRA, SEP or SIMPLE
IRA, distributions are prorated. Any deductible contributions
and earnings are taxed; your non-deductible contributions come
out tax-free, inasmuch as you have already paid tax on them.

Distributions from Roth IRAs are treated as coming first from
your contributions and then from earnings. In addition, Roth
IRAs have a "qualified distribution" rule. The first hoop to
jump through is to have had your Roth for five years. The
five-year clock starts running when you make your first Roth
contribution. If you have satisfied this five year rule, are
under age 59 1/2 and disabled, you can take out contributions,
as well as earnings, tax-free.

The 10% Early Distribution Penalty Tax

Withdrawals from IRAs that are includable in income and taken
before age 59 1/2 are subject to a 10% early distribution
penalty tax unless an exclusion applies. Note, as per the
discussion above, that contributions to Roth IRAs are not
includable in income when withdrawn.

Here are the exceptions:

1. Death. Granted, this is not the best way to start your early
retirement, but it is an exception.

2. Disability.

3. Withdrawals

that are a part of what are referred to as
"substantially equal periodic payments" (SEPPs). Using this
approach is one of the most viable solutions to early retirement
and a subject all to itself.

4. Made for medical care. However, this is limited to rules on
the deductibility of such items, which currently applies to
those medical expenses in excess of 7.5% of your adjusted gross
income.

5. For the payment of health insurance premiums, but only if
you are unemployed.

6. Made to pay for qualified higher education expenses. Not
only could you go back to school, but this also applies to your
spouse, your children or your grandchildren.

7. Made for first time homebuyers. It isn't likely that you are
hunting around for your first starter home, but this also
applies to your spouse, your children or grandchildren. The
limit, however, is $10,000. 

8. Made to a reservist while on active duty. This is a new
exception included in the Pension Protection Act of 2006. The
exception period is after 9/11/01 and before 2008.

Now that you are armed with this information, I hope that you
are in a better position to assess the viability of retiring
early. I would recommend becoming familiar with the options
available under the substantially equal periodic payments
exception. These may be the key to your early retirement.

About the Author: Robert D. Cavanaugh, CLU is a 36-year
financial and estate planning veteran and author of the free
newsletter, “The Estate Preservation Advisor”. To subscribe and
get the free video, “How to Sell Your Life Insurance Policy for
More Than the Cash Value”, go to
http://theestatepreservationadvisor.com/freevideo.htm

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