As a general rule, you need to be at least age 59.5 to get your money out of your 401(k) or IRA without facing a 10% penalty. That's all well and good if you're willing, able, and planning to work until close to a normal retirement age. If you'd like to leave the rat race before then, or if life's circumstances force you into an early retirement, however, that 10% additional haircut can be quite financially painful.
Fortunately, there are recognized exceptions that the IRS will let you apply to get at your money without it being subject to that 10% penalty. This link from the IRS website covers the key exceptions to the rule. By structuring your withdrawals appropriately, you can put more of your money to use for you once you leave the workforce.
What are two key exceptions?
One way to obtain your retirement money a little bit earlier is by separating from your job at or after age 55 (age 50 if you're a qualified state or local public safety official). You can at that point withdraw money directly from your employer-sponsored retirement plan once you separate from service. Note that if you roll the money into an IRA first, you lose the ability to take the age 55 distribution.
Another key exception, useful if you're leaving before age 55 or only have an IRA, is called the "substantially equal periodic payments" rule. In essence, the IRS lets you take an annual distribution from your account early using one of three methods. Two of the three methods, "fixed amortization" and the "fixed annuitization," require you to take the same dollar amount out each year. The third method ("required minimum distribution") requires you recalculate your withdrawal annually. More details on all three methods can be found at this link.
If you're taking the substantially equal periodic payments from your work-sponsored plan, you must have separated from service from the employer. Once you start taking those payments, you must continue them for at least five years or until you reach age 59.5 (whichever is later). If you stop early for any reason other than death, disability, or completely emptying your relevant retirement accounts, you'll be charged the penalty plus interest.
Special rules for Roth IRAs
The Roth IRA is a special situation when it comes to withdrawing money. You can take money you directly contribute to your Roth IRA out at any time without penalty or tax. Additionally, money is taxed when rolled into a Roth IRA from a traditional IRA or traditional 401(k). Once that rolled-over money sits in the Roth IRA for at least five tax years, the amount rolled over can then be withdrawn without the penalty as well.
If you are angling for a very early retirement, have saved a substantial amount in your traditional 401(k), and have at least five tax years to work through the process, this opens an interesting opportunity. That traditional Roth withdrawal strategy could let you avoid the 10% penalty while also providing you more flexibility than the substantially equal periodic payments method.
If you're considering this approach, watch out that you're not spending a quarter today to save a dime tomorrow. After all, the amount you convert is taxed at your full marginal income tax rate in the year you make the conversion. Depending on your tax bracket before and after you stop working, you might actually be better off leaving the money in your traditional plan and then paying both the tax and penalty when you need to spend it in your early retirement.
It's your money -- keep more of it for yourself
Whether you dream of leaving the workaday life early or are forced into it by circumstances beyond your control, you want your savings to last as long as possible. The rules that let you avoid the 10% penalty on early withdrawals from your retirement plan can help you keep more of what you've built up over your career. That can go a long way toward helping you make your early retirement successful.