3036: [Part 2] Generating Retirement Income Before Age 59 by Darrow Kirkpatrick of Can I Retire Yet

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[00:00:27] This is Optimal Finance Daily, Generating Retirement Income Before Age 59 and a Half, Part 2, by Darrow Kirkpatrick of CanIRetireYet.com. 72-T Rule Potentially the most accessible mechanism for an early retiree to tap retirement accounts without penalty is the IRS 72-T Rule governing substantially equal periodic payments, or SEP payments.

[00:00:55] Basically, it lays out an accounting mechanism to distribute your entire IRA balance over your remaining life expectancy. I am again going to lean on CPA Mike at Oblivious Investor to summarize the technical details. And even he strongly recommends working with a professional tax or financial advisor if you actually want to implement the rule.

[00:01:17] There is some potentially complex math involved, and if you make an error, you could complicate your financial life and set yourself up for tax penalties. Also, once you start the 72-T Road, you are essentially locked in for a period of time. You must continue taking 72-T distributions for five years or until you reach 59 and a Half, whichever comes later.

[00:01:42] Your options for changing the payment amount before that period is over are very limited, so you need to be quite certain about your cash flow needs, because it'll be hard to change your payments without penalty. And remember that the 72-T mechanism eliminates the 10% penalty, but you must still pay ordinary income taxes on the withdrawal sums. The IRS offers three methods for calculating the amount of your annual 72-T distribution.

[00:02:10] You can run the calculations for each method and use whichever amount best fits your financial needs. I won't get into the actual details here because there are really good resources online for performing those calculations, like 72T.net, DinkyTown.net, and CalcXML. Some methods produce a fixed amount each year. Some fluctuate. Some give more. Some give less. Some are simpler. Some more complex. Some you do once.

[00:02:40] Some you do every year. For example, given a $100,000 nest egg and a couple both age 50 using a reasonable interest rate of 2.45%, The calculators currently show a range of allowed annual withdrawals from about $2,100 on the low side to about $4,300 on the high side. You could choose any of the calculated amounts within this range. Borrowing. I'm generally against borrowing in retirement or before.

[00:03:09] I haven't made a debt payment, consumer, mortgage, or otherwise in about 20 years. There are so many aspects of being in debt that I dislike. The feeling of obligation to somebody else, getting hit by fees, the burden of paying interest costs, and losing time and focus to added paperwork each month and at tax time. That said, there are times when taking on debt is acceptable. In the context of early retirement, when your job income is about to stop or become unreliable or occur part-time at best,

[00:03:38] a conventional loan would be nonsensical. Even if you could get one, how would you repay it? But another type of loan, one that isn't really a loan, but it's actually a form of borrowing from yourself, made necessary by cash flow tax or regulatory considerations, could be acceptable. Later in retirement, this could take the form of a reverse mortgage, which is essentially borrowing from your home equity to finance an annuity coupled to a life insurance policy.

[00:04:06] But a reverse mortgage is a non-starter for early retirement. Most reverse mortgage programs require that you be a homeowner 62 years of age or older. But there is a rough approximation to a reverse mortgage available to early retirees with substantial equity in their homes. That's a home equity line of credit or a home equity loan.

[00:04:28] Borrowing in either of these forms to finance living expenses for a few years before reaching age 59 and a half might make sense if you plan carefully. But great caution is advised. If you take out any kind of loan in early retirement, you are assuming that you will have the cash flow later in retirement to easily pay off the loan. If that turns out not to be the case, you might be putting your home or remaining wealth at serious risk.

[00:04:53] For that reason, I'd classify borrowing to generate early retirement income as a measure of last resort only. Unfortunately, borrowing from a 401k is not a viable way to generate early retirement income because you're usually obligated to pay back the entire outstanding balance of any such loans within 60 days of leaving a job or else trigger a penalty. Special situations. I've explored the primary techniques for financing retirement before age 59 and a half.

[00:05:22] We've looked at taxable accounts, Roth accounts, the age 55 rule, the 72T rule, and limited borrowing. In addition to those primary mechanisms, there are a number of additional mechanisms that might help you generate income in early retirement. Most of them, unfortunately, apply in only specialized situations or certain kinds of accounts. One example would be high unreimbursed medical expenses for yourself, a spouse, or qualified dependent.

[00:05:49] You can withdraw some money from retirement accounts penalty-free in such situations. However, the amount you're allowed is limited to the actual expenses minus 7.5% of your AGI. In the end, the very best way to save for early retirement is probably to max out your tax-sheltered account contributions and then keep on saving into taxable accounts during your working years.

[00:06:13] Those taxable accounts generally offer you the simplest, cheapest, and most flexible way to generate retirement income. However, if circumstances limit penalty-free access to your money in your early retirement years, the options discussed earlier could still be your ticket to financial freedom. You just listened to part two of the post titled, Generating Retirement Income Before Age 59 1⁄2, by Dara Kirkpatrick of CanIRetireYet.com.

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[00:09:03] Now I'm more on board with Darrow here because he still recommends that you should fully fund your retirement vehicles. At least that's what I think he's saying when he states that you should max out those contributions. I like to say fully fund when I'm referring to my contributions to my tax-advantaged accounts because many people use the phrase max out when they're just contributing enough to get the employer match on a 401k. Oh no, no, no. You can contribute more than that, my friends.

[00:09:32] Truly maxing out or fully funding for a single person like me looks like $19,500 in a 401k, $6,000 in a Roth IRA, and $3,500 in an HSA. And you know what? Less than 10% of people do this. Even people making great six-figure salaries aren't fully funding these tax-advantaged accounts. But that wasn't the main point I wanted to make here.

[00:09:57] What I was hoping to see in this article was a more thorough analysis on eating that penalty for tax-advantaged accounts versus the loss due to taxes on after-tax brokerage accounts. Again, I like how this was addressed in the Mad Scientist article titled, How to Access Retirement Funds Early. The findings were surprising and really has me questioning if this 10% penalty is the root of all evil. And that's another episode of Optimal Finance Daily in the books.

[00:10:27] Thank you for your support and for listening every day. And I'll catch you tomorrow where your optimal life awaits.