A key difference between retiring early and retiring at age 59.5 is the ease of accessing your money. Tax advantaged accounts like 401(k)s and similar employer-sponsored retirement plans, IRAs, and HSAs all either have ages you must reach or stipulations you must meet to withdraw certain funds from the accounts. However, each of these has opportunities to use at least some of your funds sooner than age 59.5.
If you are retiring extremely early, you will probably need accounts other than retirement accounts to fund your retirement. That said, you are more likely to have these non-tax-advantaged accounts since it is difficult to accumulate enough wealth to retire at age 30 by maximizing a 401(k), IRA, and HSA alone unless you live an extremely frugal lifestyle, since the total contributions could not exceed $36,750 in 2023. (If you are self-employed or have access to multiple employer-sponsored retirement plans, this limit could be higher and potentially enough money to fund an early retirement without the assistance of non-tax-advantaged accounts. If this describes you, seek assistance to determine how much to contribute to your tax-advantaged accounts versus funds that you could access earlier to achieve your early retirement goals!) Especially early in your early retirement, accounts not traditionally considered retirement accounts are useful.
Most folks reading this article are likely considering retiring somewhere between age 30 and regular retirement age at age 59.5 or later. The closer you are to age 59.5, the fewer of these strategies you will need to use to bridge the gap to when you can access your regular retirement accounts. In addition to the more well-known "Rule of 55" and substantially equal periodic payments options, the following methods of accessing money in early retirement start with the shorter-term holdovers and progress to solutions for longer (yay!) early retirements:
Withdraw Your Roth IRA Contributions
A fun loophole to not being able to touch retirement accounts until age 59.5 is that you can withdraw your contributions to a Roth IRA at any age. Withdrawing any growth from the account incurs tax and a penalty, but withdrawing contributions from the account is completely tax- and penalty-free because the advantage of a Roth IRA is you already paid all the taxes on that money!
Your contributions are the money you actually put in the account from your income. For example, this year I am contributing $6,500 to my Roth IRA. If we assume that money doubles every eight years and I want to make a withdrawal from my Roth IRA in 20 years when I am 52 years old, that $6,500 will probably double about two-and-a-half times to about $39,000. At age 52, too young to access all my retirement accounts, I can withdraw the $6,500 I contributed absolutely tax free! However, I cannot access the other $32,500 representing the growth without paying taxes and a penalty for accessing the money early. (Once I reach age 59.5, withdrawals of contributions and growth are tax-free qualified distributions since I have already had my Roth IRA open for more than five years.)
That $6,500 may feel like a small amount of money, particularly since inflation has surely made it worth less over the twenty years since it was initially invested. However, if I invested $6,500 into my Roth IRA every year* from age 21 to age 52, I would be able to withdraw $201,500 from that Roth IRA absolutely tax-free and without penalties. Based on my own standard of living, that could support all household expenses for around three years. Patrick and I have moderate expenses among folks planning to retire early, so those with lower expenses could make that $200k cover more years while those with higher expenses would be able to cover less time. (Oh, and your spouse can also contribute to their Roth IRA and withdraw the contributions early, doubling the time this method can cover your expenses.)
But you can get more than those few years from this Roth withdrawal concept if you also have a Roth 401(k)! When you quit or retire, roll over your Roth 401(k) into your Roth IRA so you have one account from which to withdraw. Then, withdrawing your Roth 401(k) contributions is just as easy as withdrawing your Roth IRA contributions. If you maximize contributions to a Roth 401(k) for your entire career, you amass a large amount of money in contributions that are accessible before age 59.5. The 2023 contribution limit to a Roth 401(k) is $22,500. If you contributed $22,500* to your 401(k) from age 21 to age 52, you would have an extra $697,500 to withdraw tax and penalty-free between ages 52 through 59.5 in addition to that $201,500 from the Roth IRA. I do not know about you, but $899,000 could get our household through those first 7.5 years of retirement quite luxuriously!
In reality, you probably did not maximize a Roth 401(k) in those early years. I contributed to a Roth IRA from the moment I graduated from college, but I did not start maximizing my Roth 401(k) contributions until I jumped from making less than $50k to making $70k at age 27. (Before that, I still made sure to get my full employer match, and you should too!) Maximizing Roth 401(k) contributions can feel particularly difficult since you are paying the taxes on your full salary rather than realizing the tax benefit of a traditional 401(k).
But there is still another option to enable early withdrawals if you contributed to a traditional IRA or 401(k)! Using the Roth conversion ladder, you can slowly shift tax-deferred contributions from a traditional IRA or 401(k) to a Roth IRA to eventually allow you to withdraw the contributions tax free. This requires more planning prior to your retirement date because you must transfer the money at least five years before you plan to withdraw it. For example, if I want to withdraw my contribution at age 52, I must convert the money from my traditional account to my Roth account by age 47 to meet the five-year waiting period. If you do not meet the five-year waiting period, you will incur the early-withdrawal penalty.
When converting money from a traditional account to a Roth account, there are no limits to how much you can convert. So why not convert everything you need for early retirement five years before, even if you are retiring at age 35? You still have to pay taxes on that money when converting it from traditional to Roth because you are no longer deferring taxes. Converting large sums of money at once will put you in a high tax bracket. However, if you know you want to retire in ten years, you can use a Roth conversion ladder to slowly convert funds from traditional to Roth over the course of a few years, converting as much as possible without paying too high of a tax bill.
Use Your HSA and Pay Yourself Back for Previous Qualified Medical Expenses
Withdrawing contributions from Roth accounts, particularly if you also convert some traditional funds, will likely cover your 50s in early retirement if we are working backwards. But say you want to retire in your 40s. Gain a couple years using the most magical account, your HSA. There are two ways to use your HSA to foster your early retirement.
First, make sure you are actually using your HSA to pay for all your qualified medical expenses once you retire early. It is easy to overlook bandaids, a new pair of glasses, or allergy medication. These are HSA-eligible expenses. Rather than figuring out whether you can withdraw more from your Roth IRA to cover these expenses, just use your HSA.
The second level of using your HSA to cover your qualified medical expenses takes you from basic personal finance to an expert level of financial maneuvering. (That makes this sound sketchy and illegal, but it is not. It just requires masterful organization skills.) You can save receipts from all HSA-eligible purchases for your entire life, pay for these qualified medical expenses with your regular checking account or credit card for years, and then reimburse yourself for all qualified medical expenses from your HSA when you hit early retirement. That is right! You can reimburse yourself for years of qualified medical expenses, if you save the receipts. In that time, your HSA hopefully grew, since it was invested in index funds, and has plenty of value to cover these expenses with money left over to cover future qualified medical expenses.
There is no time limit on reimbursing yourself from an HSA for eligible expenses, except that the eligible expenses must have been incurred after your HSA was first opened. (If you roll one HSA into another, the earlier starting date is the one that counts.) Just be sure you can demonstrate that any out-of-pocket expenses from years ago were not already reimbursed. Track your expenses and reimbursements in a spreadsheet, save your receipts, and cross-reference the transactions with the annual tax forms you receive each year (which you also save!) showing the total HSA contributions and distributions.
Enjoy Your Passive or Semi-Passive Income Streams
Many early retirees use real estate or other diversified investments to retire early in order to set up semi-passive streams of income that are available in early retirement. Maintaining income streams into retirement is a great way to facilitate accessing money. Particularly if you are retiring very early, this consistent income can set you up for life.
Using passive or semi-passive income streams requires no tax finagling or transferring on your part. You are just getting money without working! The one word of caution with passive income is that few streams of income are truly passive. Unless you receive enough book royalties to support your lifestyle, you need to identify the right balance for you. Find a level of passivity that does not interfere with your plans and goals for early retirement. If you own real estate, this may mean hiring a management company and sacrificing a percentage of the rental income to be relatively hands-off regarding the operations. It could also mean holding onto a property for a stream of income for the first portion of your early retirement and cashing out when you know the payout plus your Roth contributions could support your lifestyle until age 59.5.
Live off the Lower Tax Rates of Your Brokerage Account
You can retire at age 30 without multiple streams of passive or semi-passive income, but you will need a brokerage account or other investments that can be accessed before age 59.5. A brokerage account is the easiest way to prepare for a long early retirement. There are no initial tax advantages when investing your money in a brokerage account, but you pay a lower tax rate on any capital gains you withdraw than you would pay when receiving income from a job. As a reminder, the highest federal tax rate on capital gains is only 20%. If your taxable income is only $44,726, your income tax rate is higher at 22%. The earlier you retire, the longer you get to enjoy those low capital gains taxes. (If you can survive off of less than $492,301 in withdrawals a year, you will not even get to that 20% capital gains tax rate and can enjoy paying only 15% of taxes in 2023. Compare that to income taxes on your current salary.)
While brokerage accounts are the easiest way to invest for an early retirement, they are not the only way. I have a Fundrise account that I plan to use in early retirement. Its only rule is that I incur a penalty on money withdrawn less than five years after it was first deposited. Since I started the account in 2020, that means I just need to wait to make any withdrawals until at least 2025 (easy, since my planned early retirement date is 2028!). With other investments, just be sure to read any policies concerning time commitments or fees associated with withdrawing the money early. If the timing works with your retirement goals, diversifying your portfolio can be a great idea. If you plan to retire at age 30 and the investment requires a 20-year commitment before you can withdraw any funds without penalty, that investment may not be right for you. Choose investments that work not only with your risk tolerance but also your early retirement timeline.
Additional Nuance
There are a number of circumstances that require you to look at your own early retirement plan and figure out exactly what the best path is for you. If you are the same age as your partner and make similar investment choices, following the same schedule is easy. If you and your partner are more than a year apart in age, that impacts planning. Collectively, your early retirement plan only needs to get you both to the point where the first person will be able to access their retirement accounts. For example, Patrick is older than me, so our rough early retirement plan looks like:
Phase 1: Semi-retired, still working for Phippen Tax & Financial Services to cover our expenses without saving additional money for retirement
Phase 2: Likely still only semi-retired because we like doing some of this work, but scaling back and letting our brokerage accounts and investments like Fundrise cover our expenses. We intend to drain most of these accounts before reaching regular retirement age while our retirement accounts continue to grow. Depending on how early we transition to this point, it may be supplemented with Roth contribution withdrawals and/or HSA reimbursements.
Phase 3: Access Patrick’s retirement accounts since he turns 59.5 first. Again, it is fine to drain these accounts because they experience less growth before we access them while my retirement accounts will continue to grow over this time.
Phase 4: My retirement accounts will be large by the time they are used. The money already invested will double more than three times before I hit 59.5, and I currently have a couple more years of maximizing contributions that will double at least 2.5 times before withdrawal. Thank you, compound interest.
Other factors to consider include receiving an inheritance or owning a life insurance policy on an older relative. You should never expect or rely on an inheritance: Folks’ financial situations can change, and we are huge proponents of people enjoying their money while they are alive! However, even if your relatives spend their liquid assets living their best lives, you may inherit a paid-off house that will increase your wealth. My suggestion for situations like this is to remain aware that this could happen and consider how it may adjust your plan, but do not retire at age 30 assuming that money will come to you at age 50 with no contingency plan.
Even with life insurance on an older relative that you own and pay for, know that the date is uncertain: Never forget Jeanne Calment who signed over her apartment at age 90 with the contingency that she could live there until her death. She lived until age 122, outliving the man meant to inherit the apartment. Jeanne is a key example of why I will always remain a proponent of amassing enough wealth to follow the 4% rule rather than trying to guess how long I will live. Something will happen in your early retirement years that you cannot predict now. It may add or subtract from your wealth. Be prepared with contingencies and the awareness to adjust.
* This will not happen precisely because IRA and 401(k) contribution limits rise gradually over time according to inflation and wage growth. The good news is that if you are young, you will likely be able to contribute even more to your Roth IRA and have more money at that age! However, inflation will likely make the ending amount about the same, regardless of when you retire.
Comments