Planning for an Early Retirement? Don’t Get Caught in This Trap

It’s great to have a healthy nest egg, but not so great if you’re penalized for using it when you choose to. If you’ve gotten a late start on the savings and investing front, then early retirement may not be so feasible for you. But some people begin setting money aside for retirement as early as their 20s with the goal of giving themselves the option to exit the workforce at a younger age than most. There are many benefits to retiring early. It might lead to a better quality of life and improved health. So if you’re working your hardest to build up a giant retirement nest egg, you’re on the right track. That said, if your goal is to retire early, then you’ll need to be careful about where you put your money. Choosing the wrong accounts could put you in the position of having to wait to retire — even if you have millions of dollars in investments.

Make sure you’re not too restricted

You’ll generally hear financial advisors say that it’s a good idea to house your retirement investments in a 401(k) or an IRA since these plans offer nice tax incentives. But one thing you should keep in mind about these plans is that if you take funds out of them before you turn 59 1/2, you’ll be hit with a 10% early withdrawal penalty. So if your goal is to retire in your 50s (or even younger), then you will need to keep some of your assets outside of a traditional 401(k) or IRA. That way, you won’t have to worry about being penalized for taking withdrawals. Now, that said, in some cases, you can access funds from a 401(k) penalty-free prior to turning 59 1/2. You may be able to take penalty-free 401(k) withdrawals starting at 55 if you leave your job the year you’re turning 55 or later, and if you’re withdrawing from a 401(k) that’s sponsored by the employer you leave at that time. This rule gives you a little more leeway as far as 401(k) withdrawals are concerned. But it doesn’t apply to IRAs. And also, it has limits. You may want to retire before the age of 55. And if you’ve saved up enough money, that should be an option. So think twice before putting all of your savings into a 401(k).

Don’t trip yourself up

Many people enter retirement with no savings at all. But if you have been steadily investing throughout your working years, you might end up with a $3 million nest egg by your early 50s, and that could be more than enough money to support an early retirement. But the last thing you want to do is lose a significant piece of that money to penalties. Nor will you want to be forced to postpone retirement simply because your money is tied up in the wrong types of accounts. So if you’re serious about retiring early, you may want to deploy somewhere in the ballpark of 65% of your investment dollars in an IRA or 401(k), but then keep the remainder in a taxable brokerage account. Going this route will mean you miss out on some tax breaks. But it could also mean getting to wrap up your career exactly when you decide you’re done.