Early Retirement - Financial Freedom (Investing, Tax Planning, Retirement Strategy, Personal Finance)

Understanding Early Withdrawal Strategies: Rule of 55, SEPP, etc.

• Ari Taublieb, CFP®, MBA • Episode 181

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Could the secret to a fulfilling early retirement be nestled within the Rule of 55 and the 72 T distribution? Prepare to unlock the potential for stepping away from work confidently, as we peel back the layers of retirement planning, keeping it simple, yet profound. We're saying goodbye to the mundane and hello to an episode filled with practical insights and real-life scenarios that will not only educate but also entertain. Discover how being 'qualified rich, cash poor' may affect your golden years, and I'll even let you in on the legality and strategic advantages of tax gain harvesting with stocks like Apple. 

This episode is a journey through the essentials of retirement income strategies, where I share stories from the trenches and the psychological hurdles that can challenge even the savviest of planners. We'll examine why downsizing or part-time work isn't just about cutting back but can be a clever move for optimizing your tax planning. With the help of our recent guests Lindia and Cole, we'll navigate the healthcare landscape, ensuring you're equipped with knowledge that's as actionable as it is engaging. So, if you're eager to sculpt a retirement plan that's as secure as it is satisfying, tune in and let's get your financial future in gear.

Create Your Custom Early Retirement Strategy Here

Get access to the same software I use for my clients and join the Early Retirement Academy here

Ari Taublieb, CFP ®, MBA is the Vice President of Root Financial Partners and a Fiduciary Financial Planner specializing in helping clients retire early with confidence.

Speaker 1:

We're back to the standard episodes this week. So I had two guests on both, lindia and Cole. We went over awesome healthcare stuff. Hopefully you guys like those Back to my standard episodes where it's just me talking, and hopefully you guys are not falling asleep to understand what you need to know so you can retire early with total confidence. I try to make it as fun as I can. I wanna make sure that you guys are listening going. Yep, that's super helpful, but at the same time I'm not giving you information that does not apply to you.

Speaker 1:

So today is an interesting episode. I think it's a fun one because I don't want you guys to be worrying about a lot of stuff that does not apply to you and your coworker may have brought it up, or your neighbor, and I just want you to give. Essentially, I'm giving you the job that I give my clients, which is for you to tell that coworker or that friend wow, that sounds really cool, but it doesn't apply to me. And that's what I'll tell my clients, because a lot of them are really intelligent, smart people that are in these positions where they're constantly being told different ideas about their finances and they're like, hey, I don't know who to listen to, who not to listen to. So I tell them. Part of my job is to tell you stuff not to worry about. And then there's going to be things that those coworkers or friends or neighbors never bring up and I'm going to tell you. I need you to strap in and listen to this piece. So today it's going to be fun. I'm going to talk about the rule of 55, the 72 T distribution, all these fancy techniques that can be really helpful, and situations when I tell clients never to use them or never even consider using them, and these are things that I hope, if at all, today you go, wow, that does not apply to me.

Speaker 1:

I've thought about it a few times. I'm glad I'm going to put that in my head trash corner, which a lot of you guys know that term. There's a lot of head trash that you have. Should I be doing that? If markets take a downturn? Can I still retire early? And how soon before I retire, should I shift my portfolio? And how do I not get killed by taxes? All big concepts that I talk about, but a really big one is wow, there's some different things. I hear about when I should tap into funds and how do I know what should be in my 401k, versus you talk about some brokerage account and you call it a superhero. I don't even know what you mean by that. How do we dive into all that? So today I want to simplify. More than anything, there's a lot of the early retirement fluff out there in my opinion. So here's my idea.

Speaker 1:

So we're going to go through this every week, I'll take a comment from YouTube or a review left on the podcast and I'll highlight that, and then what I'm going to now introduce and that's because of this comment here is a new segment where I'm not only going to highlight a recent review that was very kind, but I'm going to either bring up a comment that wasn't so kind and respond to that, or I'm going to just highlight a funny comment that I saw each week, and here's why. So this first comment comes from let's Not Bicker and Argue that is their YouTube channel handle and it says thanks, ari, for addressing and explaining these trade-offs regarding Roth conversions and healthcare subsidies. We're thinking of taking the best of both worlds option maybe ACA subsidies now at 60, followed by Roth conversions between starting Medicare and RMDs, as you say. It will depend on our portfolio's performance and the degree to which tax rates change in 2026. We've been using new retirement, which indicates the future tax savings after Roth conversions are approximately equal to five years of subsidies. For me, your channel and podcast continue to provide the perfect education and entertainment as I plan for retirement, thank you.

Speaker 1:

So when I read that comment very kind comment, so thank you for that In my head I'm like, well, that's pretty cool. I want to definitely entertain. That's why I'm doing what I'm doing, because if I just were to say, hey, here's what a Roth IRA is and keep it really dry, well, it just wouldn't be that fun and engaging and therefore you wouldn't essentially get as much value because you would stop listening to it. It's like as if someone's like you should have broccoli every single night. It's like, hey, I know I probably should, but if I only eat that, get me wrong. But I want to make it entertaining. At the same time I want to make it educational. So I could say hate comment, but it's really not a hate comment, because all of you guys are very kind, even when you do constructive criticism, excuse me. I want to make sure that all of you do know that you have the ability to tell me anything. I'm going to read it, I'm going to see it. I actually like reviewing this.

Speaker 1:

And so here I am, four minutes into the podcast and I'm yet to get to my rule of 55 and 72 T and the stuff I want to get to, but I'm trying to make this show what I hope is your go-to every Monday. Yep, I'm going to learn something that's going to help me for my early retirement, or, at the very least, I'm going to learn some things that I used to worry about, that I'm no longer going to worry about, and, if not, that you're entertained learning about some financial strategy. So this one comes from Dave Compton five one, five zero who says some constructive criticism. This is the first video of yours that I clicked. I've watched the first two minutes and you aren't even to the first item. Please get to the point.

Speaker 1:

So I actually really liked that comment because it actually helps me go. Hey, should I be getting to my points faster? What can I do to help? Because this is your podcast and this is your channel. So if a hundred of you go, yep, don't need any of those stories already about you talking about your clients doing this or that and spending. Nope, just tell me exactly how much to convert and then I'm going to go convert. And the reason I don't do it it's not because I'm a mean guy, but it's because I just don't think it's as valuable If I just tell you, yeah, fill up to this bracket, you go do it and you go wait a second. But my spouse and I have an age gap and wait a second. You know I'm going to want to do part-time income. So it's like I can give you an answer. It's just not that helpful of an answer. So I want to person said this in the comment, but that certainly does not kind of resonate with me. I like the story. So if you guys want a podcast and a different description, or if you guys want me to go into more stories or go, hey, I'd love weekly episodes, or I'd love episodes twice a week where one's a story and one's more, just kind of going through the financial example of that, I try to blend it both and make them effective and put them into a tight 15 minute, 20 minutes, sometimes 10 minutes, sometimes 30 minute podcast. So try to make this as helpful as I can for you guys. So those are the two comments.

Speaker 1:

Now let's talk about what we want to talk about today. I'm gonna give you a few examples, but here's the first thing. So the rule of 55, what is this? When does this make sense? So let's assume you're turning 55 or older and you don't have any other accounts, just a 401k, and you're like, oh my God, ari, I'm going to freaking. I don't know what I'm going to do, but I'm so miserable at work. I don't want to get another job, maybe in the future, but I just I want out. Okay, which I don't hear often, because most of my clients are reaching out going, hey, I just want to optimize. I kind of like what I do. I just want to make sure I'm doing it because I want to, not because I have to. And then what they find is they end up continuing to work anyways or they do something less stressful. That's what I see most of the time.

Speaker 1:

In this particular situation, the rule of 55 would make sense if someone had, for example, $500,000 in a 401k. They have no cash, no rental properties, no spouse with income, no future part-time income. They're just like, hey, I refuse to work ever again. I don't want to spend a lot of money. That's where this rule of 55 makes sense. What I often see is people go wait a second, I'm going to retire early. Let's call it 57. I don't know how much longer I've got my health and my energy. This early retirement concept sounds good to me.

Speaker 1:

I also didn't save a ton of assets outside of my 401k or my Roth IRA or my HSA. So, you know, I don't really know what to do and I don't want to simply, you know, be screwed just because I didn't save into a brokerage account. So there's a phrase I made up. I mean, you know I do this in a silly way, on purpose, so you guys remember it. And so my parents. They are house rich, cash poor, and they let me talk about their story, where they have a home that's worth $6 million in Malibu and they're working in their seventies because they have a home that they love, they never want to sell, so it's really not an asset, it's not throwing off any income, but they love it. So they're, and luckily, they love what they do, so they're going to continue doing it. But they are house rich, cash poor, working in their 70s, and they were burned by a few advisors, which is why I am an advisor Now that's house rich, cash poor.

Speaker 1:

The phrase I'm talking about is qualified rich, cash poor. You're like huh. What I mean by that is I don't want you to save so much that all of a sudden, you go. Wait a second, what if I don't love this job and I want to switch and I'm going to need income? Well, if you save so well to your 401k or your IRA, your 403b, and there's no pension that starts for a few years, there's no social security and there's no rental income, Well, all of a sudden, where's income going to come from? If you do want to switch your life around and to me that's the power of money is that you can go live the life you want to live. So the idea here and I illustrate it through this other example and I'm going to connect it all back, I promise A client came to me and they had about 6.2, $6.3 million and they were 53 years old and they want.

Speaker 1:

They hated their life, they wanted to quit their job, but they had no other assets. So I said listen, what you can do based on your assets is you can take the funds out. And once again, they didn't want to do this, but they had the option I said you could take the funds out and you can pay a 10% early withdrawal penalty in addition to taxes you have to pay. But because you saved and invested well and you did a really good job, you can still do everything you want to do, but yeah, you're going to pay this penalty and switch jobs. And they could not get it inside themselves to this concept of paying the penalty because they were just like, wait, that concept of me taking $100,000 out and paying this 10% penalty, I just can't get myself to do it. So we had a lot of planning session and eventually they did it.

Speaker 1:

But the point here is there was a lot of hesitation and it's because they saved so aggressively to these qualified accounts. These accounts you can't touch until you're 59 and a half. So then some of you are going to go wait a second. What about that rule of 55,? Huh, you know this person. If they're 53, what if they just waited two more years? Well, they didn't want to. But the point here is let's assume they were 55. And let's use the real example. Let's assume this person was 55. What they could do is they could retire January 2nd, january 1st in the year that they turn 55, and they can skip the 10% penalty.

Speaker 1:

People are like, whoa, this is pretty cool. You're telling me I don't have to wait till 59 and a half. And I'm saying, yeah, and most plans allow this. It's called the rule of 55, where you can take from your 401k at 55, not 59 and a half. People are like, oh my gosh, why didn't you tell me this earlier? Why don't I see it everywhere? Well, you can take it, but I often don't recommend it. I don't like when people do, and here's why, even though it's a cool strategy that is once again available to you, it doesn't mean you have to use it. So I'll tell clients yeah, you can absolutely pull from it, but it actually gets in the way of our tax plan.

Speaker 1:

People are when you take that money, yep, you avoid the 10% penalty, but it's as if you're just withdrawing more money from your IRA or 401k. It's as if you're just working. It's just ordinary income when you pay taxes on it. So what it does is it shoots up our income. So let's assume they've got $6 million in a 401k and they're taking income let's just say, $100,000 out to live. Well, if they take $100 thousand dollars out, that doesn't leave us a lot of flexibility to do Roth conversions, which is going to reduce their future tax bill. Because once again, if you've got 6 million bucks and that's growing and compounding well, maybe it's 10, 15, 20 million dollars once RMDs have begun and now you're just getting absolutely destroyed in taxes.

Speaker 1:

So what I'll tell a client is if you, for example, are 53 right now and you're going, hey, I've got two years until I can tap into that rule of 55. And what I would encourage you to do is, instead of adding more dollars to your 401k, maybe start to add new dollars on purpose, even if you're in a high tax bracket, avoiding a tax deduction, which I get. It sounds kind of scary at first because you're like why would I do that? But it's to bolster up this brokerage account, this superhero account that's what I call it because it allows you to retire earlier. There's no tax benefit you get, but you can take the funds out really as soon as you'd like and there's no special tax penalties. So someone's like, hey, I kind of get it.

Speaker 1:

But just give me like a simple example to just come home on this. I go okay, let's assume, like most of you, you've got a million dollars. So let's even say 2 million. So let's say $2 million. And let's say you're 52 years old. Okay, so you're 52, you got 2 million. You may have had a thought at some point hey, I don't know when I can tap into my accounts, but I saw this Fidelity article about the rule of 55. So I'm going to tap into that. Okay, so you start to use that at 55. Well, if you were to do that and work three more years now at 55, let's say you've got 2.2 million bucks I don't know, whatever it is Well, now you're withdrawing from it and you have no other way to withdraw income for the rest of your life.

Speaker 1:

So now here you are, from 55, living until Social Security starts and let's assume you start that at 67, and RMDs are at 75. Well, now we've got you know a lot of time where this money is going to grow. You're living off of it. But what you're not allowed to do is what's called really. You're allowed to do it, but it wouldn't be efficient Quality Roth conversions, where you move the money from your IRA to your Roth IRA. And the reason it's not effective is because you're taking money out of your 401k and that's creating income. It's filling up brackets as if you just make more money.

Speaker 1:

So now let's say, okay, what's the pro tip here? Well, the pro tip is what if you're 52 and you've got $2 million and you say, hey, I don't want to retire. I don't know exactly when, but you know, I just want a job that's less stressful and maybe I'm going to scale back in a year or two? Okay, well, what if you're making 250250,000, $300,000. What I would like to see is that person try to save outside of the 401k, maybe $30,000, $40,000 a year. So now, let's assume they're 55 now and let's just say they've got $75,000. Well, if they, for example, live off that $75,000 in the first year at 55, well, now they could live off of that. And they're paying capital gains tax as opposed to paying what's called ordinary income tax, which is higher. So it's keeping your tax bill lower, which allows you to do a really cool tax playing technique like a Roth conversion.

Speaker 1:

And then we take it to the next level. What about tax gain harvesting? And some of you have heard of this concept. Some of you go, hey, you have heard of it, but I just never understood it. And sometimes you got to be told these things multiple times in different ways before it really connects.

Speaker 1:

And so tax gain harvesting is this idea that what if you bought Apple stock, let's assume, at 52, let's assume, let's keep it simple 2 million bucks in a 401k at 52. And you've got a brokerage account and you haven't put any money into it. But you heard me talk about it and you looked up superhero online but you couldn't find it anywhere. That's a joke, because it's not actually a superhero, but my brokerage account. So now you're 52 and you're starting this for the first time and you put $10,000 into Apple stock. Okay, well, if that $10,000 grows and now you're 55 and it's worth $50,000, it went up by 40,000. Awesome, you can take that money out and, assuming you have no other income, pay 0% in taxes. Okay.

Speaker 1:

But like well, is that totally legal? Is that like Ozark stuff on Netflix? No, this is legal. You're allowed to do this. It's called tax gain harvesting and I have separate video where I go over this in a whole lot more detail, where I literally just do that for 15, 20 minutes. So if you want to fall asleep, check that one out. Just kidding, hopefully you're not falling asleep. Listen to this stuff.

Speaker 1:

So this is the next level of planning is how do I think about the rule of 55? When do I use it, when do I not? Well, you want to use it If you're 55, you're totally miserable, you have no other income sources and you are like I need out and I need income. Well, then it makes sense. It's a great option. You can pull from it and you can go live. Before that I'll often look at okay, does it make sense to downsize? Are there, can you work at least part-time and maybe pull in some income that way, saved to a brokerage account, because it allows you to do all this really cool tax planning that adds hundreds of thousands of dollars over the course of your lifetime. So the pro tip is to have some brokerage account that allows you to keep your income low, to qualify for capital gains tax preferential treatment instead of ordinary income.

Speaker 1:

The rule of 55 is really cool, but to me it's almost one of those things that it's there as a backup. It's hey, if God forbid something happens, I could pull from that and then you don't have to go back to this. You know very stressful job, but more often than not I'll say can we find a job you really enjoy and you do that for longer. Or maybe you're like, no, I want to travel and start enjoying my life and I've got no other way to pull income. Well, great, maybe we use a portion of it, but maybe not all of it. And so sometimes I'll tell clients let's use a brokerage account for a few years and then if we need to use that rule of 55 at call it 57 or 58, we can use it then. But at least we did some good tax planning the first two, three years.

Speaker 1:

So the overall message here is hey, you have a way to tap into income before 59 and a half. That's awesome. And if you only have a 401k and you just saved really well to that, great, you didn't do anything wrong and it's an option. But too many people simply hear it and go, whoa, I can tap in earlier. Let me do that. And it's just because there's a cool tax strategy and a technique. It doesn't mean you need to use it. So that's the first one.

Speaker 1:

I wanna go over the other one. Here I put a quick example on rule 72T. So what is this? Well, it lets people and it's a great idea, it lets you tap into your IRA, so not just your 401k, which we were talking about before. So not just your 401k, which we were talking about before, but it lets you tap into your IRA before 59 and a half. And so some people listen to this and go oh my gosh, once again. Why was I never told this before? This is awesome, yes, it's awesome, but once again, if we pull any money from an IRA or a 401k, it increases our income, which means we're filling up tax brackets and we're not able to be as effective with all the other aspects of our plan.

Speaker 1:

A client came to me, said Ari, I'm 63. Here's how much I have in assets 1.2 million. I've got another 500 in the brokerage and I've got 200 in Roth. What do I do? When do I take Social Security? I said, hey, tell me about your parents when they collected Social Security. And they're like why are you asking me about that stuff? Just tell me the answer and I go.

Speaker 1:

Here's how you determine Social Security, level one. Level one is what most people do is go eh, maybe I collect earlier. I know it's not as much of an amount that I could get if I waited, but you know I get it for more years. Nothing wrong with that. Level two yeah, I'm going to delay my benefit. I'm going to get a greater one if I wait. And you know, ari, you might not know this, but you know if I were to wait, my partner's going to get the larger benefit. So if something happens to me, they're going to get that for the rest of their lives. That's pretty cool. I said that's level two, also once again a good thought. Level three is ignoring all of that and saying wait a second, don't marry your strategy. But as we're looking at building the plan and when you're going to collect Social Security, understand, the earlier you turn on Social Security, the less effective tax planning is. People go huh and I go.

Speaker 1:

Well, if you turn on social security at 62, what happens is let's assume it's $50,000 between two people. Well, now it's $50,000 and there's probably another income source and there's probably rental income and there's probably a pension, and so what happens now is we can't do those Roth conversions effectively, and the Roth conversions could legitimately save hundreds of thousands, if not millions, of dollars. So I don't want you to try to save $2,000 a year in taxes if I could save you $600,000 over the next five to 10 years. So the point here is your social security. Number one don't marry it, because we might build out this Roth conversion strategy and we might do all the conversions that we think are effective and that might be done at 64. And then all of a sudden it's okay, we did a really good job doing these conversions. We implemented the strategies we want now for the rest of your retirement. I'm totally cool.

Speaker 1:

You turn on social security when you want, when you feel right, because there's no real answer. If there was a real answer, it'd be really easy. But what happens more often than not is people go well, you know, my parents weren't in the best health and they turned it on. I've been paying into it for so long and, listen, I don't even know if it's going to be there when I'm older, so should I even rely on it? The big thing with social security is saying okay, when makes most sense based on my tax strategy, how effective was I with conversions? Did I get that done efficiently? A lot of you are listening right now in your 30s, 40s, 50s, early 60s, going hey, I've got some time before I have to make a social security decision and all I ask is that you don't marry it Every single year you're identifying. Does it make sense? Does it not? I'd even argue more than a year.

Speaker 1:

But bringing this back to the rule 72T, what is this rule 72T? Well, it allows you you don't have to pay the 10% penalty and you can tap into your funds before 59 and a half. So here's the example Number one. There's some really strict rules. So when, like, does this make sense? How to think through this? Let's assume John is 55 and you saved 500,000 bucks in your IRA. Okay, now I don't know what it's growing at, but let's just say 5%. Well, what you're able to do and I've put an example here is you're able to essentially take out a portion not as much as you want and once you decide you want to take it out, you have to take that portion out really every single year, and you could say it's a 10 year withdrawal period. There's a lot of factors to determine here and there's three different ways of doing it. There's the RMD method, the amortization and the annuitization, so different methods to do it.

Speaker 1:

But here's the main thing. 72t that's the rule for what this tactic is, which is called substantially equal, periodic payments, where you're intentionally taking a certain amount for a certain amount, a minimum. So what you can't do is just do 58 and go on at 59 and a half. No, now you have to do it for at least five years, whichever is longer. That's the answer. So there are penalties if you stop, there's still taxes due. So all you're doing is saying OK, here I am, I'm 56 and I've got no other way to create income. I don't have a 401k and I've got no other way to create income and I don't have a 401k. I'm gonna, at a minimum, pull $50,000 a year from my IRA. And you have to do that for at least five years. You couldn't just stop at 59 and a half, because if you started at 56, well, that's only three and a half years, so you would have to continue doing it.

Speaker 1:

And some people are like what's the problem with this? Oh, my gosh. You're telling me I could just turn this thing on and then I could get income, and I don't have to wait until 59 and a half and I'm going to need income anyways. So, like, why wouldn't I do this? Well, it sounds good because you're turning on 50,000 every single year, or a hundred, whatever it is. But the problem is you turn it on once again. Now that's locked in for five years and if something comes up and you determine, well, I want to do something else or you don't want to turn that income on for whatever reason, because you're not spending as much that year, whatever it is, well, now all of a sudden you've locked yourself into doing that and there's some heavy penalties and things you don't want to deal with.

Speaker 1:

Going in that realm, what I would rather you do is once again say wait a second, can I save to a brokerage account? And that's the ultimate flexibility here. It's not going to make you go oh my gosh, am I going to be okay or not? You're going to be okay. And if we needed to use the substantial, equal periodic payments? I've executed it once as an advisor and I've seen hundreds of people come through Root, go, hey, should I consider this? And I get to say, no, it doesn't apply to you, you don't need to do it. You have this brokerage account. Your neighbor might talk about it. Your job is say that sounds cool, that does not apply to me. So there's a lot of details to this If you want to really implement this.

Speaker 1:

To me, it's one of those things that you optimize too well. Well, you've got your IRA. You've got your 401k. Part of my job, you know I love optimizing. My nickname is literally optimized at the firm. Like we know, ari's weekend wasn't fine. It was optimized. But I want to make sure you're not optimizing so much that you don't leave yourself flexibility or the opportunity to determine part-time income.

Speaker 1:

I don't want you to use these strategies that you hear because they sound cool Rule of 55 or 72T. These are all great options, but it doesn't mean you have to use them and, to be honest, I very rarely do so. Your takeaway from today might be wow, I'm never gonna worry about those, ever again. They don't apply to me. It might be ooh, that could be interesting. Maybe a backup if something doesn't pan out the way I want. What if I don't love my job, or part-time income isn't a good fit for me? Whatever it is, these are good backup options, but I definitely don't think you should be relying on them. So these are my thoughts.

Speaker 1:

Hopefully this episode resonate with you. If you're looking for holistic strategy on early retirement as a whole. That's what we do. So I want to make this video because I get a lot of questions on these types of concepts and there's more than this, by the way, but I just want to start going through. What are some of these things? How do you think through them? Because there's certain rules around 457s and a lot of this stuff. Is people getting too lost in the weeds, I find so? Just my experience as an advisor. But, guys, hopefully this was helpful. Hopefully it answered some questions for you. If so, please do leave a comment, even if it's a funny one, an interesting one. Leave a review on the podcast. It helps more people find the show, that's.

Speaker 1:

My only ask is if you're digesting this. I love doing this, but I love hearing from all of you more than anything, so please do let me know and I'll see you guys next week. Thank you for listening to another episode of the early retirement show. If you have a question that you want answered in a future episode, you can always go to my website, early retirement podcast dot com. That's early retirement podcast dot com, and you can go ahead and submit a question that I'll look to answer in a future episode. Thank you all for listening. Please do rate it, review it and share it with someone who you think would benefit from this information, if there's anyone out there that you know. I certainly appreciate it and I will see you all each week. Hey guys, it's me again. Please be smart about this. Nothing in this podcast should be construed as financial, tax or legal advice. Consult with your tax preparer or financial advisor before taking any action. This podcast is for informational purposes only.