What retirement accounts are available without age based withdrawal penalties?

Question

If you retire early and have money invested in a Roth IRA or a traditional 401k, that money can't be touched without penalty until you're 55/59. (Let's ignore Roth contributions that can technically be withdrawn). Are there any other investment accounts that are geared towards retirement or long term investing and have some perk associated with them (tax deferred, tax exempt) but do not have an age restriction when money can be withdrawn? Are you limited to a generic taxable brokerage account?

Answer 1

The biggest and primary question is how much money you want to live on within retirement. The lower this is, the more options you have available.

You will find that while initially complex, it doesn't take much planning to take complete advantage of the tax system if you are intending to retire early.

Are there any other investment accounts that are geared towards retirement or long term investing and have some perk associated with them (tax deferred, tax exempt) but do not have an age restriction when money can be withdrawn?

I'm going to answer this with some potential alternatives. The US tax system currently is great for people wanting to early retire. If you can save significant money you can optimize your taxes so much over your lifetime!

401ks and IRAs

If you retire early and have money invested in a Roth IRA or a traditional 401k, that money can't be touched without penalty until you're 55/59. (Let's ignore Roth contributions that can technically be withdrawn)

Ok, the 401k myth. The "I'm hosed if I put money into it since it's stuck" perspective isn't true for a variety of reasons.

If you retire early you get a long amount of time to take advantage of retirement accounts. One way is to primarily contribute to pretax 401k during working years. After retiring, begin converting this at a very low tax rate. You can convert money in a traditional IRA whenever you want to be Roth. You just pay your marginal tax rate which.... for an early retiree might be 0%. Then after 5 years - you now have a chunk of principle that has become Roth principle - and can be withdrawn whenever.

Let's imagine you retire at 40 with 100k in your 401k (pretax). For 5 years, you convert $20k (assuming married). Because we get $20k between exemptions/deduction it means you pay $0 taxes every year while converting $20k of your pretax IRA to Roth. Or if you have kids, even more. After 5 years you now can withdraw that 20k/year 100% tax free since it has become principle. This is only a good idea when you are retired early because you are able to fill up all your "free" income for tax conversions. When you are working you would be paying your marginal rate. But your marginal rate in retirement is... 0%.

Related thread on a forum you might enjoy. This is sometimes called a Roth pipeline.

Basically: assuming you have no income while retired early you can fairly simply convert traditional IRA money into Roth principle. This is then accessible to you well before the 55/59 age but you get the full benefit of the pretax money.

But let's pretend you don't want to do that. You need the money (and tax benefit!) now! How beneficial is it to do traditional 401ks?

Imagine you live in a state/city where you are paying 25% marginal tax rate. If your expected marginal rate in your early retirement is 10-15% you are still better off putting money into your 401k and just paying the 10% penalty on an early withdrawal. In many cases, for high earners, this can actually still be a tax benefit overall.

The point is this: just because you have to "work" to get money out of a 401k early does NOT mean you lose the tax benefits of it. In fact, current tax code really does let an early retiree have their cake and eat it too when it comes to the Roth/traditional 401k/IRA question.

Taxable accounts

Are you limited to a generic taxable brokerage account?

Currently, a huge perk for those with small incomes is that long term capital gains are taxed based on your current federal tax bracket. If your federal marginal rate is 15% or less you will pay nothing for long term capital gains, until this income pushes you into the 25% federal bracket.

This might change, but right now means you can capture many capital gains without paying taxes on them. This is huge for early retirees who can manipulate income. You can have significant "income" and not pay taxes on it.

You can also stack this with before mentioned Roth conversions. Convert traditional IRA money until you would begin owing any federal taxes, then capture long term capital gains until you would pay tax on those. Combined this can represent a huge amount of money per year.

HSAs

So littleadv mentioned HSAs but.. for an early retiree they can be ridiculously good.

1. You can invest them
2. You pay no FICA (for employer plans, sorry self employed people!)
3. You can withdraw medical expenses whenever. Not only the year of contribution (like FSAs)
4. At age 65 effectively turns into IRA (except the FICA benefit remains)

What this means is you can invest the maximum into your HSA for 10 years, let it grow 100% tax free, and save all your medical receipts/etc. Then in 10 years start withdrawing that money.

While it sucks healthcare costs so much in America, you might as well take advantage of the tax opportunities to make it suck slightly less.

Related Resources

There are many online communities dedicated to learning and optimizing their lives in order to achieve early retirement. The question you are asking can be answered superficially in the above, but for a comprehensive plan you might want other resources.

Some you might enjoy:

• MrMoneyMustache
• ExtremeEarlyRetirement
• GoCurryCracker

Answer 2

The point is to provide for yourself in retirement, so it makes sense that these withdrawals would be penalized.

Tax deferred accounts are usually created for a specific cause. Using them outside of the scope of that cause triggers penalties.

You mentioned 401(k) and IRA that have age limitations because they're geared towards retirement. In the US, here are other types, and if you intend to spend money in the related areas, they may be worth considering. Otherwise, you'll hit penalties as well. Examples:

1. HSA - Health Savings Account allows saving pre-tax contributions and gains towards medical expenses. You must have a high deductible health plan to be eligible. Can be used as IRA once retired.

2. 529 plans - allow saving pre-tax gains (and in some states pre-tax contributions) for education expenses for you or a beneficiary. If a beneficiary - contributions are considered a gift.

3. There's a tax benefit in long term investing in a regular taxable brokerage accounts - long term capital gains are taxed at a preferable (lower) rate than short term or ordinary income. The difference may be significant. Long term = 1+ year holding. The condition here is holding an investment for more than a year, and there's no penalty for not satisfying it but there's a reward (lower rates) if you do.

Answer 3

you can begin drawing retirement income from 401k, ira and roth accounts at any age. the key is that it must be retirement income. you can't blow it all on an epic party, but you can withdraw a modest amount every year while preserving enough capital to last the rest of your life. there are 3 common strategies for doing this:

1. if you want to withdraw relatively large amounts of money, you can establish a roth conversion ladder (aka roth conversion pipeline). the strategy relys on a rule which says roth conversion funds are available for penalty free withdrawal like regular roth contributions after 5 years. so essentially, you can convert 1 year's worth of spending from your traditional ira (or 401k) to your roth ira each year. after doing this for five years, you get to withdraw 1 year's worth of spending each year tax and penalty free. using this strategy you can retire at any age as long as you have 5 years notice (or can live for 5 years on other funds like your regular roth contributions). this strategy is advantageous because you can adjust your withdrawals up or down to match your actual spending, and you can adjust your conversion amounts up or down to maximize your tax brackets (or match your actual spending with a 5 year lag).
2. you can make penalty-free withdrawals from a traditional ira account at any age by establishing a substantially equal periodic payments plan (sepp). basically you just have to withdraw a modest retirement income every year from the year you start until you turn 60. the irs rules for calculating your annual withdrawal are somewhat complicated, but it's a relatively conservative amount designed to make your savings last until you die. importantly, this payment plan is established on a per account basis, so if you want to withdraw an even smaller amount, you can simply move some funds to a separate account and establish a sepp there. you can always increase your total withdrawals later by adding a sepp to another ira account.
3. you can withdraw your roth contributions at any time tax and penalty free. it is only the earnings which are restricted. i don't think you should discount this option, because unless you plan on dying young you will probably contribute more during your working years than you withdraw before turning 60. as a quick example, if you assume a 7% return on investments and equal annual contributions from age 30 thru 45, you could withdraw roughly 4% of the account balance every year from 46 age thru 60 without ever touching the earnings. obviously, if you want to max out contributions in your 20's and retire in your 30's then your withdrawals would have to be more conservative, but in that case you will almost certainly need more savings than you could possibly fit into the annual contribution limits. that means the funds stuck in your roth account will be a relatively small part of your portfolio.

side notes:

1. if your employer provides (vested) matching funds in your 401k, then you would probably be better off contributing enough to get the matching, even if you almost immediately withdraw the money and pay the tax penalty.
2. when first starting out, investing in in a regular brokerage account can be more tax advantageous than an ira account because you can deduct up to 3k$ per year in losses at your earned income rate (e.g. 25%), while you can pay taxes on gains at the long-term capital gains rate (e.g. 15%). so even if you just break even on your portfolio, you can end up saving several hundred dollars per year in taxes. the trick is to realize losses early, while deferring gains.
3. a health savings account (hsa) contributions are tax deffered like a traditional ira, while withdrawals are tax free like a roth ira (if used for medical expenses). it's important to realize that any qualified expense after you establish an hsa can be reimbursed at any point in the future. e.g. you can fund an hsa with 1k$ today, pay for 10k$ in medical expenses tomorrow, then withdraw 10k$ from your hsa 30 years from now after that initial deposit has grown large enough to cover the expense. if you never incur medical expenses, then an hsa effectively becomes a traditional ira once you turn 60. do not confuse a health savings account with a health spending account (usually called a flexible spending account or fsa).

techinical details:

roth conversion ladder:

1. you cannot withdraw roth conversion funds for 5 years from the date of conversion.
2. you cannot withdraw earnings from a roth until 5 years after the date you opened your first roth account.
3. you cannot withdraw earnings on a roth conversion until you turn 59.5 (with certain exceptions)

substantially equal periodic payment plans:

1. payments must continue for 5 years
2. payments must continue until the account holder turns 59.5 years old
3. payments must be withdrawn at least once per year
4. once a payment calculation option is chosen, it cannot be changed to any option other than the (most conservative) required minimum distribution option
5. establishing a plan eliminates penalties, but not taxes. as such, it cannot effectively be used to make early withdrawals from a roth
6. you cannot begin a sepp from your 401k while still employed at the sponsor, however some employers allow you to perform an ira rollover while still employed at which point you could establish a sepp in the rollover ira.

Answer 4

This may be more of a comment than an answer, but it's too long for a comment. Perhaps the Stackexchange Gods will forgive my impudence. That said:

Even with the tax penalties, it can be to your advantage to put money into a "retirement" account and withdraw it before retirement. The trick is: Is the amount of the tax penalty more than the benefit of untaxed compound growth?

For example, just to make up some numbers: Suppose you have $1000 of gross income to invest. You are considering whether to invest in an ordinary, non-tax favored account, or a classic IRA. Either way you will get 10% returns. Your tax rate, both when you put the money in and when you take it out, is 15%. There is a 10% tax penalty for early withdrawal.

With an ordinary account you will pay 15% tax off the top, so you are only investing $850. Then each year 15% of your returns are paid in taxes, so your net return is 8.5%. But when you withdraw the money there are no additional taxes.

With an IRA you do not pay any taxes up front, so you can invest the entire $1000. You collect 10% each year with no taxes. When you withdraw, you pay 15% plus the 10% penalty equals 25%.

So after 5 years, the ordinary account would yield $850 x 1.085^5 = $1504. The IRA would yield $1000 x 1.1^5 x 0.75 = $1208. The tax penalty hurts. You are better to use the ordinary account.

But if you could leave your money in for 25 years, then the ordinary account would yield $850 x 1.085^25 = $7687. The IRA would yield $1000 x 1.1^25 x 0.75 = $8126. The IRA, even with the tax penalty, is better.

Of course my numbers are just made up. What your tax bracket is, what returns you get, and how long you think you might leave the money in the investment, all vary.

Answer 5

A 457(b) plan allows access to funds after you separate from your employer, regardless of age.