Early Retirement and The Rule of 55

Whether you are a DIYer or are someone that is beginning to focus on retirement planning for your family, I hope this topic helps provide information that helps you take that next step in increasing your retirement confidence.

The rule of 55 is an IRS rule that allows for a distribution without penalty from your employer’s retirement plan once you separate from service and are 55 or older. However, 59 ? is the standard age limit for most retirement account withdrawals without penalty (401(k), IRA, Roth, etc.). The rule of 55 has allowed many of our clients to retire prior to reaching age 59 ? without penalty, strategically reposition their assets for current and future income tax purposes, and fund a new business venture.

One Time Shot(Depending on Employer)

Although this rule helps provide flexibility between jobs or approaching early retirement, it is very rigid in use because it may be a one-time deal, depending on whether your employer allows multiple distributions after termination. It’s best to come up with a plan before you take the shot. All traditional retirement plans distributions are considered taxable income. You’ll also want to consider the following:

·      Will Your Assets Last If You Never Return to Work

o  You can determine this by forecasting expected returns, withdrawal needs, and life expectancy assumption. You’ll also want to account for inflation, which is a silent retirement killer.

o  Remember that the number one fear of retirees is running out of money, be sure to make conservative assumptions to ensure that you have the highest probability of succeeding with your retirement goals.

·      Current Taxable Income

o  Depending on your immediate needs for access to your employer retirement account, it may make sense to urgently process your distribution request using the Rule of 55 or delay until the New Year, in which your taxable income will reset. You’ll want to monitor your tax bracket and verify that there are no surprises when your taxable income increases or decreases (Healthcare Subsidies/Medicare, Tax Credit Phase-outs, Etc.) For these reasons, I’d recommend visiting with your tax professional and Certified Financial Planner to way your strategy decisions.

o  Many of our clients work for Tech Companies that offer Enhanced Retirement Packages that may result in a large cash payment to separate from service. This may occur in the year the package is accepted or may allow for payment to be made during the following year depending on the package structure.

o  Stock Options may need to be exercised and Restricted Stock Units may receive accelerated vesting, which could add additional taxable income that you’ll have to plan for. Selling older shares that had previously vested and that have substantial gains could impact your tax situation if that was one of the additional sources you plan to tap for early retirement.

·      Next Year Taxable Income

o  In addition to a retirement package deferring income into the following tax-year, you may have already contributed or your employer may have offered a Deferred Compensation Plan. Review your elections as they typically require you to make your preference at the time of deferral (year following termination, 3- year payout, 5 year payout, etc.)

·      Other Resources Available

o  If you determine that the best strategy is to defer your income until the following tax year, you may want to utilize other resources: Employer Stock, Non-Retirement Assets, Savings, Roth Account Principal, and Home Equity Line of Credit. Each of these resources have their own unique impact on your retirement planning and should be choreographed ahead of time to maximize the effectiveness of your plan.

·      Roth Conversions During Lower Income Years

o  Depending on your pain threshold for paying taxes, doing Roth Conversion in years that your income is drastically lower than it has been in previous years allows you create more tax diversity in retirement years. With life expectancies reaching into the upper 80’s, it’s very likely that the income tax landscape will shift multiple times throughout your retirement years.

·      Once You Rollover Into an IRA You Lose the Ability to Use the Rule of 55

o  Before you rollover your employers plans into your IRA account at your preferred custodian, it is important to recognize that you’re giving up this unique strategy by doing so. You can, however, simultaneously request a distribution using the Rule of 55 and rollover the remaining funds into your IRA account. Depending on what your employer requires to request these forms of distribution, be sure to have a professional walk you through the process as the process can vary greatly and often use confusing terms and wording.

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If you are in the window of possibly using this strategy in the coming years, congratulations! You’ve worked very hard and long to get to this place. It’s a great time to review where you are at and where you hope to go in the future. Moving forward until retirement and post retirement your decisions are going to carry a significantly greater weight as the feeling of “I can’t mess this up because I either can’t go back to work or don’t want to go back to work”.

Reach out to a professional that is collaborative and that you can trust. After all it is your plan and not the advisor’s.

I’m always available to answer questions on this topic or another topic of your interest. If you found that this topic was informative and valuable, please like, share, or comment so that your friends and colleagues have the opportunity to view the information too.