The Personal Finance Podcast - How to Access Your Retirement Funds Early!

Episode Date: July 28, 2021

64. How to Access Your Retirement Funds Early We launched a Youtube Channel! Check it out here. Master Money on YouTube. Got questions? Ask me on Instagram Here. @mastermoneyco This is the fastest way to get a response from me. You can also ask questions on TikTok @mastermoneyco Sponsors Thanks to Mint Mobile for Sponsoring the Show! Get your new wireless plan plus free shipping at mintmobile.com/pfp. Thanks to our sponsor Manscaped (Manscaped.com) for sponsoring this episode of the podcast. Use code PFP20 at checkout for 20% off + Free Shipping! Thanks to Mini Cooper for Sponsoring the show! Check out the all-electric Cooper SE. Reserve yours at MINIUSA.com Want to Support the Show? Follow on Spotify or Follow and Leave a 5-Star Review on Apple Podcasts! Today We Discuss:  How to Access Your 401(k) funds early. How to Access Your Roth IRA funds early. The steps I am taking to access my retirement accounts in FIRE.  Why this is important.  IRS Document for SEPP PLAN Radical Personal Finance More Episodes You Will Love:  The Super Retirement Account (HSA) How much you need to save to retire  Why Understanding Your Savings Rate Will Change Your Life (and Allow You To Retire Early) The Roth IRA Millionaire  The 401(k) Millionaire  Check out all the Stuff I Recommend!  M1 Finance Open a Roth IRA Personal Capital Free Wealth Management + Budget App and Fee analyzer!  CIT BANK (Best Savings Account) Best Personal Finance Books  The Simple Path to Wealth - J L Collins  The Millionaire Next Door - Thomas Stanley I Will Teach You To Be Rich - Ramit Sethi  Rich Dad Poor Dad - Robert Kiyosaki ** Some links may be affiliate links and we earn a small commission at no extra cost to you. We only recommend products we truly believe in.  Check us out on social fam!  Twitter Dollar After Dollar Instagram www.thepersonalfinancepodcast.com www.dollarafterdollar.com Learn more about your ad choices. Visit megaphone.fm/adchoices

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On this episode of the personal finance podcast, we're going to talk about how to access your retirement funds early. Post is about.com. And today on the personal finance podcast, we're going to talk about how to access your retirement funds early. If you have any questions about this episode, hit me up on Instagram at dollar a F-T-R dollar and follow us on Spotify, Apple Podcast, or whatever podcast. or you love listening to this podcast too.

And if you want to help out the show, leave a five-star rating and review on Apple Podcasts. So once you start thinking about fire or you want to retire early and you're thinking about financial independence and you start to plan this out, you realize there's a major hole in this system. There's a major conundrum.

And the biggest catapult to fire is that people always talk about, well, make sure you're contributing to your 401K, make sure you're contributing to your Roth IRA so that you can get the biggest tax benefits. And we talk about that all the time on this podcast because it is a major advantage for you to get your money into retirement accounts

so that you can save on the taxes. But the question then becomes, once you get your money in those retirement accounts, how do you access those retirement funds because you can't withdraw that money until you're 59 and a half without paying a penalty? And if you tap into those retirement accounts before you're 59 and a half, you have to pay a 10% penalty in addition to the taxes.

We'll never fear, my friend, because there's a loophole. And I'm going to show you how you can access these funds early. If you understand these loopholes, you can use them to your advantage. And this is where financial education always comes into play. Because understanding these types of things allows you to do things like retire early, which is a loophole in and of itself. It's a financial hack so that you can access. the funds early as well. Because what some people do is if they don't understand these concepts,

they will forego contributing to their retirement accounts and just start contributing to taxable brokerages. And the problem with that is you don't get the tax saving advantage and your pile of cash will not grow as much. Your pile of cash will lose the advantages that come into play when you actually invest in retirement accounts. So if you do that, if you start contributing to taxable brokerage accounts instead of your retirement accounts because you want to retire, early? That's crazy to me because you need to take advantage of every single tax benefit that the government gives you. You need to take advantage of every single one because you're being taxed left and right. So if you could take advantage of these, it's a major wealth catapult for you.

It's a major way that you can actually get your funds to grow significantly more. And even if you plan to retire early, you still need money to live in your 60s, 70s, 80s and beyond. So why not at least take those tax deferred years or potentially even tax-free money no matter what. Because if you don't take advantage of these tax accounts now, if you don't take advantage of your Roth IRA or your traditional IRA or your 401K, you'll lose the opportunity forever because it's a year-by-year basis. You can't go backwards. You can't start contributing to these accounts on the back end.

You have to take advantage of every single tax break, every single year. And this is why it's so important to save your money, to earn more. so you can put as much money as possible into those brokerage accounts. Because if you don't, you lose the opportunity. And lost opportunity is one of the biggest problems when it comes to your personal finance. The people who take advantage of opportunity early on, those are the folks who are extremely successful. Now, if you're starting late, if you're starting to invest late, we have an entire episode about this. But if you started investing late, it doesn't matter.

Seize the day now because that is what you have to do to take advantage of compound interest and take advantage of these tax benefits so that you can build long lasting wealth that you can hand down for generations to come. So if you're interested in retiring early or if you're interested in accessing your retirement accounts early, then this is the perfect episode for you. Now let's get into it. Now the first system that we're going to talk about is called a Roth conversion ladder. And this is the way that I like most to be able to access your retirement funds early. This is the way. that I implement, and I'm going to implement in the future, to access my retirement funds early.

Now, before we get into the Roth conversion ladder, I want to say this up front, because if you're trying to access your retirement funds early so that you can spend the money instead of being retired, maybe you're still working full time at your job and you just want to spend the money on something big, maybe you want a down payment on a house or something like that. Here at the Personal Finance podcast, we do not recommend that. You do not touch your retirement funds until it's time to retire. Unless you're in some sort of major emergency, you never touch your retirement funds. Because doing that interrupts compound interest unnecessarily. And the last thing you want to do with your money is interrupt compound interest unnecessarily. Because compound interest is a snowball

machine. And once you realize that, it will start spitting off cash for you. It's literally printing money for you. And so allowing your money to grow as much as possible and not drive. And not drawing down your money unless it's for something you value extremely, like your freedom, that is when you start to draw it down. And that's why we do this. That's why we put our money where our mouth is and we put it into retirement accounts so that we can buy our freedom, which in my opinion is the number one thing that you can buy with your money.

Freedom is the number one thing that you can buy with your money. So tapping into these accounts early so that you can buy something frivolous or so that you can buy something maybe that brings you value, that's not worth it. in the long run unless you're buying freedom. That's the point of this entire system. And that's the point of contributing to your retirement accounts. So the Roth conversion ladder is by far the number one way that I am going to utilize to access retirement funds early.

And we've talked about this a number of times on this episode, that the Roth IRA has tremendous wealth benefits. And if you remember, if you've listened to our Roth IRA episode, you can withdraw any contributions that you put into the Roth IRA without penalty. And then what comes into play with that is the first five-year rule. So if you max out your Roth IRA every single year, and at the time I'm recording this, it's $6,000 a year, then you can withdraw that $6,000 at any time.

But the first five-year rule states that you must wait at least five years after your first contribution to a Roth IRA to withdraw the earnings tax-free. So if you're just starting a Roth IRA, you have to wait at least five years before you can withdraw some of that money, tax and penalty free. So understanding that up front is going to help you understand how this entire thing works.

Because that is one of the major benefits of a Roth IRA. If you get into a pinch and you get into a major bind, you can still withdraw the funds that you put into that account tax free. Now the growth money

is not going to be penalty free. So let's say you put in $100,000 into your Roth IRA over the course of a decade or so. And that money grows to $300,000. Well, all you can pull out penalty-free is that $100,000 that you contributed. The $200,000 that it grew, you cannot pull that money out penalty-free. So let me show you how you can increase the amount that you're

contributing to your Roth IRA so that you have more money that you can withdraw penalty-free early on. If you have a 401k and if you have a 401k at your company, obviously we always talk about having a 401k at your company or a traditional IRA if your company has that because you want to get the employer match. And so if you get that employer match, and you contribute to it and you max it out because you want to take advantage of those tax benefits, when you leave your job, immediately roll over your 401k or your 403B into a traditional IRA. And since all of these accounts, the 401K, the 403B, and the traditional IRA, all are very similar when it comes to taxes.

This conversion can be done immediately and there are no penalties or tax consequences that you have to worry about. So what you're going to do is you're going to roll it into a traditional IRA. Now, if you are to contribute to a traditional IRA and don't have a 401k, you can skip this step. Number two, then what you're going to do is if you need to access some of your retirement account money in the first five years, then convert the amount you think you'll need from your traditional IRA to a Roth IRA. The major key to this conversion is you will have to pay tax on the amount that you convert.

So what you want to do, and the biggest thing you want to do with this, is make sure you're in a low tax bracket when you make this conversion. Why? Because you will pay significantly less taxes than you would if you're at your peak years. So a lot of people who are pursuing financial independence, some of them are high earners. So for example, let's say you're a high earner and you try to make this conversion, well, you're going to be paying 25, 35, 40% in taxes depending on what situation that you're in, whereas if you wait until you're close to retirement or you're making less money or you're retired,

you're going to pay almost nothing in taxes in comparison. So if you're in a low tax bracket, let's say you're in a 15% tax bracket because you don't make as much money in the final years, then that would be the time to make this conversion. This is a major pro of barista fire. And we've talked about barista fire a number of times in this episode. We're going to have an entire episode on this because people love this concept. And I think it's one of the coolest concepts when it comes to fire.

But within barista fire, what you're doing is you're taking a lower paying job, but being able to work, you know, one, two, three days a week. It's called barista fire because it's like you can go work at a coffee shop for two days a week just to supplement your income and you can retire a little earlier. And at that point in time, that's a perfect time to make this conversion because you're going to have to wait a certain period, which we'll get into a number three here. And so it allows you to make up that time. And it's a major pro to barista fire because you can access these retirement funds early, still do something you love and have these tax benefits. Because number three is you got to wait five

years when you do this conversion. And while you're waiting within those five years, then you can start doing a ladder or additional conversions, meaning in year six, you do another conversion, and your seven, you do another conversion so that you can access those funds each and every year. So you can see why barista fire would be really beneficial within these two concepts, because if you're in a lower tax bracket, you can start converting each and every year. And then once you're done and you're just ready retire, then you can go ahead and head into retirement. And then after five years, number four is after or five years, you can take out the money you converted without paying any additional penalties or taxes. Guess why? Because this is money that you contributed. So let's say you have a million

$401K. And you convert that million dollar 401k into traditional IRA. And you're not going to have pay penalties and taxes on that because they have similar tax structures. Once your money is in a traditional IRA, then you can roll the traditional IRA money into a Roth IRA. And when you do that, when you roll it into a Roth IRA, all of a sudden, you've contributed that money, haven't you? So that's an actual contribution. What do we say at the top of the show? Your contributions to your Roth IRA, you can withdraw as long as it's within five years.

So if you wait five years, all of a sudden now, you can actually take that money and utilize it early in retirement. See how this works? So within those five years, you can still have that money invested. It's going to grow tax-free. And so you're going to make additional income on that. But this is a way to really beef up your Roth, and it's a beautiful way to do this, so that you can actually get the money going.

Now, like I just said, when you contribute to your Roth IRA from a traditional IRA, you're going to have to pay taxes because a Roth IRA, you pay taxes on the front end, it grows tax-free, and you pull it out tax-free. So there's a number of pros to this method. reason why I like this, but it's because you can minimize your taxes that you have to pay because you're rolling it in when you're in a low tax bracket. That's one of the major benefits of this, because you're paying significantly less taxes, even when you're contributing to your IRA, you're not paying taxes on the front end while you're in a high tax bracket, and then you're

rolling it into a Roth while you're in a low tax bracket. See what you're doing here? No taxes when you're a high tax bracket. Rolling it into a Roth when you're a low tax bracket. It's a beautiful system to actually implement. And if your income is low enough, let's say you're retired and your income is low enough, you could potentially execute tax-free conversions. You could literally have tax-free conversions if your income is low enough and not have to pay any tax on that money at all. So if you have zero income for five years, maybe you saved up five years of cash and you have zero income coming in, you could literally pay zero dollars in taxes, which is a major benefit to having cash flowing assets, maybe something like real estate or

something like that, where you can really lower your income or just keep it in the LLC and in the business for those five years, and then you have a bunch of different things that you can do in a bunch of different options. There's so many options with this system, this is why I like it so much. And if you don't need to use the money, you can leave the conversions in your Roth to grow tax-free until you need to use them. So maybe you have another system, like I just said, where you don't need to use the money right away. Then you can wait, have the flexibility to let that grow in the Roth, and now you have a big old fat Roth that you can wait before you need to use the funds. Now the downs. this system is you have to wait to five years. That is a major downside because five years is a long time.

It's a long time to wait, which is why I like to pair this with barista fire or some other thing that you can utilize. Maybe you have a business or rental properties that you can live off the money for a short period of time so that you can wait for this conversion to happen. And the other con is you have to pay tax on the conversion five years before you can actually use the money so you lose out on those benefits as well. But I'm going to show you two other options and they may benefit you in your situation more so. So let's get into it. So lately, I've been noticing how fast things are changing at home. The kids are growing like crazy, clothes don't fit anymore, and routines are changing. And it just hits you. Life is expanding. And when your life grows, your responsibility grows with it.

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withdraw every single year is predetermined by formulas that the IRS sets out. So the IRS has these formulas that they set out and you have to pick which plan you want to do. So it almost works the way like a pension would work where you're getting the same amount of income every single year. But if you quit the set plan before it concludes, then you have to pay penalties on all the money that you were trying to avoid, and you have to pay interest on those amounts as well. So a set plan is best suited for somebody who has a steady stream of pre-retirement income,

and they want to just compensate for the career that they just left. So that's who it's best for. It's best for someone who doesn't need flexibility. They are okay with the income coming in. Maybe they have real estate investments or other things, and they're okay with that income coming in, and a set plan will allow you to access their retirement funds early at a set amount.

If there's a recession year and your money's invested, You don't have the opportunity to withdraw less funds if you want to. So it really does hurt you on the flexibility side. Now, if you don't need that flexibility, maybe you have a massive IRA, then this would be a good option for you. But if you need that flexibility, which most people do, then it might not be the best option for you. So this method just has the least amount of control in my eyes.

But here's the steps on how it works. So when you leave your job, you immediately roll your 401K or your 403B into a traditional IRA. And if you have a traditional IRA, you can skip this step. and then you determine how much you think you need to withdraw from your retirement accounts every single year until you return 59.5. So you're predetermining this, which is the part I don't like. But if you're okay with that, this is a great option. And then you calculate the three possible withdrawal amounts.

Now there's an IRS document that you utilize for this, and I'll leave a link to it in the show notes, and you pick the one that's closest to the number you decided in step two. And then you definitely, in these types of situations, when you're doing something like this with the IRS, You need to make sure you're speaking to a tax professional to ensure you're doing the calculations correctly. You don't want to mess around with this, especially if it's your retirement funds coming in. You want to make sure that you have it correct because these IRS calculations can be complicated for most. And so you want to make sure somebody's actually looking it over. So if you don't have an accountant, that's a time to actually get one to make sure that this is going correctly.

And then what you're going to do is you're going to withdraw and pay tax on that amount every single year. Because like we know, when you withdraw from an IRA or a 401K, you're going to have to pay tax on that money because you didn't pay tax going in. And then depending on whatever method you used, you need to actually calculate the withdrawal amount, and then you may need to adjust it how much you withdraw every single year. So yearly you can change these calculations,

but if you're mid-year and inflation's risen completely and you're right on the edge, like you're on a fine line, and then everything becomes more expensive, well, now you've got yourself a problem. So you want to make sure that you're picking the correct amount every single year, maybe slightly more than you need, just to have that available to you.

But this is why you want to have an emergency fund in retirement as well because it combats stuff like this and will give you more flexibility. And then number seven is to continue making the withdrawals for five years or until you turn 59 and a half. So it's whatever is longer is how the IRS has it written up. And if you stop withdrawals or you withdraw the incorrect amount, you could face steep penalties, which I do not like about this. So definitely don't stop doing that because the steep penalties are a lot more than other situations. So the pros to this are you pay tax on the withdrawal in the same year that you spend the money, so your money can grow tax-free for as long as possible. And you can start

withdrawals immediately after retirement, whereas the method I like to use, the Roth conversion ladder, you have to wait five years. So that the pro to this is that you can start withdrawing the money immediately after retirement. But there's a bunch of cons, and the biggest con for me is that there's no flexibility in terms of how you can utilize this. Now, I love to have flexibility in everything within my personal finances. I like to make it easy. I like to make automated. I like flexible. all of those are very important to me. If that's not as important to you and you want to just be able to access that money right away,

you don't want to wait the five years and try to figure out how you're going to do this, then maybe this is the best option for you. Another con is you have to consult a tax professional to do this. And you must continue withdrawals, whether it makes sense to or not. Maybe you don't need the money one year. You got an inheritance, you got a big windfall.

Well, you still have to continue withdrawals. And if you stop withdrawals, or you withdraw the incorrect amount, then you pay penalty. And some people just withdraw the incorrect amount because they're not paying attention. And all of a sudden you make major penalties just for withdrawing a couple thousand dollars more than you were supposed to. So you have much less control. Now let's get into the final way that you can withdraw on your retirement funds early.

Now the last way to talk about withdrawing on your retirement funds is a very simple one. And this is one that a lot of people don't talk about. But it's just to pay the 10% penalty. What if you just paid the penalty of accessing your retirement funds? funds early because even if you pay the penalty, if you do the math, you still come out on top by contributing to retirement accounts because of the tax advantages. And Joshua Sheets over at Radical Personal Finance, he actually did these calculations in an episode.

I'll see if I can find that episode and link it up in the show notes, but he ran the math on this. And when he ran the math, you actually still came out on top. And it was extremely interesting episode, and he goes into great detail on the math, so I'm not going to try to do it here because his episode is like an hour. hour long on how they do this. So the beautiful thing about this is that there's no advance planning necessary. You don't have to figure out what you're going to do. You're just going to pay the penalty. And you can access the money immediately and you can utilize it whenever you need it and you don't

have to pay tax in advance. This is where the flexibility comes in as well. This is obviously the most flexible option, but you're probably going to pay a lot more than these other two options. So for me, I'm not going to utilize it. But if you needed it for a year or two, just pay the penalty. Now, 10% is a big number, especially if you're withdrawing, say, $100,000 a year. year, well, that means you're paying a $10,000 penalty every time you pull that money out. So that's why I like the first two options more than this, because paying that 10% penalty is still a good chunk of change. But if you're in a bind and you need to retire now and you can't do these other two options yet, this is something that you can still do. You can still pay

the penalty. And I'll try to find a link to that episode in the show notes as well. Now, there's one other thing I want to mention before we wrap this episode up, is that if you're utilizing an HSA, this is something that you can use as a supplement to your income. Because if you've saved up money in an HSA, and you have a significant amount in there, and you've been maxing out your HSA for the last couple of years, and it's grown because it's invested, and you have a bunch of receipts from medical bills that you can utilize, an HSA can help supplement your income because you can pull it out tax-free as long as you have receipts, medical receipts that line up with that HSA, you can utilize that as a supplement

while you're waiting the five years for the Roth conversion ladder. It just gives you additional flexibility, or it also allows you to reduce the amount that you're taking if you choose a set plan. So it gives you just additional income. If you're contributing enough, it's kind of like having Social Security in early retirement. And that's why we love the HSA so much.

If you're not familiar with an HSA, I'll leave a link to the show notes. But basically what happens is you contribute money tax-free, it grows tax-free, and you can pull money out tax-firm. as long as you have a qualified medical expense. That's the key to it. So you can save your medical expenses

in a system like Dropbox or OneDrive or something like that, and you could save the receipts, and there's no rule on how old the receipts have to be. So you can have a receipt from 20 years ago and still pull that money out tax-free because you have a qualified medical expense. Now, if you don't have a qualified medical expense, you'll have to pay penalties on that as well

until you're 65, but it's still a great option to have for supplementing that income. And I'll leave a link to the show notes to the HSA episode as well. If you have any questions about this episode, hit me up on Instagram at dollar a F-T-R-dollar and follow us on Spotify, Apple Podcasts, or whatever podcast player you love listening to this podcast and if you want to help out the show, leave a five-star rating and review on Apple Podcast. Just head on over there. Just give the five-star button a tap.

one, two, taparoo, and just say, man, I love this show. And it truly does help out the show. I appreciate each and every one of you guys. Thank you so much for listening to this episode. And we'll see you on the next episode. Rosen lasagna, medium power, 15 minutes. Sounds like Ojo time. Let's play.

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