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5 Financial Facts Every Early Retiree Should Know

By Dan Caplinger - Updated Feb 12, 2018 at 3:43PM

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For many people, the dream of early retirement is the biggest motivator to save as much as they can. Through hard work and smart financial management, you can put yourself in the best possible position to retire early.

To help you in your quest, there are some key financial facts you'll need to know. Below are five of the most important ones to keep in mind if you want to retire early.

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1. 59 1/2 is the age at which you can take penalty-free withdrawals from IRAs.

Most people know that there's a penalty for taking money out of a traditional IRA early. If you haven't yet turned 59 1/2 years old, then you'll have to pay 10% extra on top of having to include the withdrawn amount as taxable income in the year you took the withdrawal. Once you've reached age 59 1/2, there's no penalty, and you can take out as much money from an IRA as you like.

There are exceptions to the penalty rules that can allow you to take money from IRAs early without paying the penalty. For instance, if you're totally and permanently disabled, then your IRA becomes available immediately. IRAs also allow distributions for qualified higher educational expenses, health insurance premiums while unemployed, and up to $10,000 in home purchase costs for qualified first-time homebuyers. For early retirees, the health insurance premium exception can be especially valuable to help you cover costs.

2. Penalty-free withdrawals from a 401(k) can be available earlier.

401(k) and other qualified employer retirement plans have a special rule that sets an earlier penalty-free date. If you separate from service after turning 55, then any withdrawals you take are free of penalties.

That's an argument in favor of keeping money in an ex-employer's 401(k) rather than rolling it over into an IRA. Once that money goes into an IRA, the 401(k) rules no longer apply, and you'd generally have to take a penalty to get access to the money before you turn 59 1/2.

3. Substantially equal payments are another key exception.

The IRS understood that early retirees would need some access to funds early, so the law creating retirement accounts allowed for an exception to penalties for substantially equal periodic payments made according to a definitive plan. To qualify, you must commit to taking distributions for at least five years or until you turn 59 1/2, whichever one comes later. So if you retire at 50 and start taking these payments, you'll have to take them for nearly 10 years.

Complications arise in exactly how much money you have to take each year. For the most part, though, substantially equal periodic payments let you tap into a modest portion of your retirement savings each year, preserving most of it for future growth but still freeing up some access if you need it.

4. Roth IRAs and 401(k)s are more flexible than traditional retirement accounts

Roth accounts give you more flexibility with your retirement savings than traditional IRAs and 401(k)s. The most important aspect of Roth accounts is that you can withdraw your initial contributions without penalty, because they represent after-tax money that you've already paid income tax on before you made your initial deposit. With the added benefit of not being subject to income tax, Roth distributions can be particularly attractive.

Roth distributions can also be helpful in managing your taxes. By taking a mix of money from taxable and Roth sources, you can avoid paying more income tax than you have to.

5. Social Security is usually available at 62, with Medicare kicking in at 65.

For many, making sure you can reach early retirement age for Social Security is the primary financial goal in retiring early. Currently, you can get Social Security retirement benefits at age 62, at a reduced rate compared to what you'd get at full retirement age. Medicare takes longer, becoming available at age 65 for most people, and so you'll have to deal with your healthcare costs on your own in early retirement until those benefits kick in.

Be smart about early retirement

When you retire depends not just on how much you've saved but also whether you have access to that money. By keeping these things in mind, you'll better understand when you can truly decide to quit once and for all and begin the early retirement of your dreams.

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