I love when people Ask FinanceDad questions, it gives me a chance to see what people are interested in, and provide them with answers that both make sense and which give actionable advice. Moreover, half of the questions I receive, I would have never thought about myself. Therefore, your questions gives me the opportunity to often learn new things on my own and share them with you.
Reader Nick recently asked me some great questions:
I was recently told that Congress is considering raising the age at which you can begin withdrawing from a 401(k) or IRA without penalty? Is that true? What age are they considering raising it to? As a young worker just beginning my career, it troubles me to think that not only will social security not be available for me, but I also won’t be able to access my own retirement savings until so late in life.
First, Nick thanks for your questions. Now, let’s move on to answering your questions. With regards to speculation that congress is considering raising the withdrawal age, I’ve seen or heard nothing of the sort, even after an exhaustive news and blog search. On the contrary, I’ve seen proposals from the Obama administration to eliminate required minimum distributions, and to remove in partial, penalties for early withdrawal. However, for the sake of argument, let’s say congress one day does decide to pass a bill that would raise the age limit for penalty free withdrawals from 59 and 1/2 to say, like 65 years of age. Any such move would likely come as a result of increased life expectancy. Although, that doesn’t address your concern, having access to your money should you decide to retire earlier than the imposed penalty free withdrawal age.
Currently, there are completely legal ways around these penalties, for people to access their retirement funds much younger than 59 and 1/2. I wrote an article ironically, two years ago yesterday about accessing your retirement funds early without paying a penalty. With the 72(t) and 72(q), the IRS allows you to make extended, regular withdrawals penalty free. The key here is, you have to make the exact same withdrawal (with very little exception) or the IRS will slap you with the penalty along with additional interest and fines for not abiding by their rules. My point is, there are usually ways around the penalties that allow you access to your retirement funds.
But for Nick and my other readers, even if congress raises the retirement age for accessing your retirement funds and takes away the 72(t) and 72(q) and other options, you can still retire early if you plan properly. Retirement planning is a reltively simple excercise (once you understand it), which I will describe breifly below.
Say your desire is to retire at 40. You must determine what it will take to get there by looking at your starting point, and deciding how much you will need to have to be able to retire at 40 and maintain whatever lifestyle you desire. Lets say Nick is 23 years old right now, he determines he will need to have 2 million in savings and investments to be able to retire at 40 and live to 85. Nick must determine how much money he will have to have save and invest each pay period to reach that goal over the next 17 years. He must decide how much risk he needs to take to acheive his goals. If the law says he can’t touch his 401k or IRA until he is 65, or he will face a stiff penalty, he must have enough in savings to last him through retirement until he can access his other funds. He may need to have 1 million in savings, combined with half a million in investments (which will need to grow to 1 million in investments by the time he is 65 to reach his two million dollar goal in investments – if you combine his 1 million in investments with his million in savings, it totals his 2 million dollar retirement goal needs), this way he is not dependent on 401k or IRA funds in entirety for early retirement.
But you’re probably thinking, what if I plan on that basis and the government decides after I’m 40 to bump up the age for penalty free withdrawals to 70. Plan conservatively, plan with that potential worst case scenario. Planning is your friend, and will make life much less complicated and will help take away many of your worries. I’ve wrote a cool series on understanding the basics of retirement planning, I encourage you and my readers to take a look when you get a chance, it’s no more than a couple hour read and will help squelch many of your fears. It details how to make goals and evaluate them to see if they are feasible.
You’re right on about social security though Nick, however, if you plan accordingly, there’s no need to worry whether social security will be there for you when you decide to retire, I’m certainly not counting on it. In summary, think of your retirement plan as a set of stairs, you may have to live off of savings (the bottom stairs) until you’re able to access investments (the top stairs), but you can still retire early if you save, invest and plan properly.
I hope this helps!