Being a financial planner comes with a certain amount of stress.
Most would contribute the schizophrenic stock market as the leading culprit of the high stress levels.
And that is absolutely correct. Dang you market!
Coming in at a very close second is helping a client strategically plan for their early retirement.
What do I define as an early retirement?
Any client that is retiring before they can attain social security (and don't have a pension). Trying to help ease the income needs for retirement puts added stress to make sure they don't run out of money in their golden years.
An additional level of stress occurs in making clients stick to the plan.
Too often clients start viewing their retirements accounts as ATM machines, and I have to make sure they don’t get too crazy with their spending habits.
Oh yes, early retirement can be very stressful for all parties involved.
The BIG Mistake
When it comes to making the biggest mistake in retiring early, I’ve seen it done countless times and it can be a very costly one.
So, what’s the big mistake? Let me illustrate by sharing a recent conversation I had with an individual that had recently changed jobs and had to make a decision with his old 401(k).
This individual was 50 years of age and had a decision to make with his 401(k). He had been at his previous job for a number of years and his 401(k) had collected a nice sum of approximately $500,000. He was trying to make the decision whether to roll the 401(k) to his new 401(k) or roll it over to an online brokerage like Scottrade or eTrade. In the conversation, I could tell a lot of his focus was on fees, where to invest the money, access to the money, etc.
The one part that he failed to consider is what happens if he wanted to retire early. After some initial fact finding, I asked a simple question:
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Do you plan on retiring early?
He quickly shot back and said
“Yes, my hope is that I can retire somewhere around the age of 57.”
That simple statement leads to ultimately the biggest mistake that many people make when changing jobs and retiring early. A little known IRS rule allows folks that retire early, starting at the age of 55, to take premature distributions from their employer sponsored plan while avoiding the 10% early withdrawal penalty.
How is this all a mistake? The mistake has everything to do with the technicality of the term “employer sponsored plan”. Employer sponsored plan would include your 401(k), 403(b), TSP, or 457. What that does not include is your IRA’s.
That’s right, your IRA, according to the IRS, is not an employer sponsored plan, so if you roll that over into an IRA, you lose the ability to take out your money and avoid the 10% early withdrawal penalty. And the last time I checked, no one likes to pay a 10% penalty just for the fun of it.
Had this individual rolled over his 401(k) into an IRA, he lost this inherent gift from the IRS.
Not Just About Job Change
It doesn’t just have to happen when you change jobs. I’ve seen several people that prior to working with me had retired early and rolled their 401(k) into an IRA not knowing about the 10% free withdrawal rule. Unfortunately, the majority of the time that I’ve seen it, the individual is working with a financial advisor that failed to disclose this. Either the advisor wasn't up to speed on the rules, or I think their eyes were on the prize, meaning that they would only get paid if that client rolled over the money into an IRA that they managed. Do I have proof? No, just call it a hunch.
If you’re planning on retiring early, please keep in mind that to avoid paying an unnecessary 10% early withdrawal penalty, you must leave your money in the 401(k). Don’t make that mistake.
Note: Within in IRA, you are allowed to take premature distributions if you follow rule 72t or meet certain conditions. 72t is a more complex planning strategy that ties up your money for a minimum of five years. If you want more rules about 72t, feel free to check out another post where I wrote about the 72t rules and ways to avoid penalty on withdrawals from your IRA.
Are you planning on retiring early? Have you thought about rolling your 401k into an IRA? If so, be careful!