By Steven Jamison, CFP®, CPA
Have you been dreaming of retiring early but you’re not sure how to do it? If you plan it the right way, you may be able to retire sooner than you think while also paying less in taxes over your lifetime.
Doing this, however, requires you to take advantage of lesser-known tax rules while at the same time making a long-term tax plan. Both components can help make your retirement dreams a reality.
Using Lesser-Known Tax Rules
One prominent misconception in the financial world is that you cannot access your retirement money without a 10% penalty until age 59.5. That is typically the case if you have money in an IRA or retirement plan like a 401(k) or 403(b). However, there are actually two exceptions that early retirees can use to their advantage.
The first exception is called the Rule of 55. Using this rule, you can take distributions from your company’s retirement plan, without penalty, if you leave the company during or after the calendar year you turn 55. (1)
A number of rules surround this type of withdrawal. For instance, it only works with your current retirement plan (it can’t be a former employer), and not every retirement plan allows for these distributions. This strategy won’t work for everyone, but if it works for you, it’s a great way to access your money before the traditional retirement age.
The second way you can access your money before 59.5 is by using Rule 72(t), which allows you to take distributions from your retirement accounts as long as your distributions are substantially equal payments for either 5 years or until you turn 59.5, whichever is longer. (2)
Despite the misconceptions that exist, there are ways that you can access your money before age 59.5 and not pay that 10% early withdrawal penalty.
However, as you navigate early retirement, it’s imperative to not trip yourself up and make a costly mistake on any portion of the tax code. If you’d like help honing in on the specific strategy best suited for you, that’s exactly what we do at Jamison Hanson.
Smart Tax Planning
As you head into the home stretch of your career and enter retirement, it’s important to pay attention to your tax plan. Many early retirees focus on their asset allocation (how much you have in different asset classes like stocks and bonds) but don’t spend as much time on something called their tax allocation.
Simply put, your tax allocation is how much you have in taxable accounts, tax-deferred accounts, and tax-free accounts. Each of these accounts has different tax treatment when you withdraw money, and it’s important to consider if you have the right amount in each type of account.
For instance, most people have almost all of their investments in tax-deferred accounts, which means when they make a withdrawal, they will have to pay taxes on that amount. If tax rates rise in the future, you could be on the hook to pay a higher tax rate, with little flexibility to avoid it.
However, if you start your tax plan right now (which often takes years to fully implement), you can consider if it makes sense to increase contributions to tax-free accounts. Specifically, you could make a contribution to a Roth IRA, health savings account, or consider a Roth conversion. If one or all of those options make sense, it will give you much-needed flexibility in terms of where to take your distributions in retirement, and potentially save money on taxes.
Tax Rate Planning
Another factor to consider is your tax rate during your working years and your future tax rate in retirement. A lot of early retirees earn the most they’ve ever made in their 40s and 50s, which means they’re in the highest tax bracket they’ve ever been in—and likely will ever be.
Yet when you transition into your early retirement, your income is likely to fall. If your income is still high, it might make the most sense to contribute as much as possible into pre-tax accounts, where you can deduct your contributions from your income, and delay paying the tax on that amount.
When you distribute it and your income is much lower, you can pay taxes on that money at a much lower rate. That extra money you save on taxes could help extend how long your portfolio will last, which is especially important if you plan to have a longer retirement than normal.
Get Started Today
If you’d like help navigating the complexities of the tax code so you can pay less in taxes while retiring earlier, we’d love to help. To start planning for your early retirement, schedule a 15-minute introductory call online or reach out to me at (503) 391-1040 or email@example.com.
About Jamison Hanson
Jamison Hanson is a full-service, fee-only financial planning and accounting firm. The firm name was changed to Jamison Hanson in 2021 when Steven Jamison and Dennis Hanson joined their firms, but the firm’s roots extend through decades of time and early founders whose legacy the firm retains. Our mission is to make life easier for our clients by serving as their personal financial concierge and assisting with tax compliance, investment management, and other financial needs.
Steven Jamison is President at Jamison Hanson, a full-service, fee-only financial planning and accounting firm. As a Certified Public Accountant and CERTIFIED FINANCIAL PLANNER™ professional, Steven uses his specialized knowledge of tax, financial, and management matters to enhance the lives of personal representatives and trustees and professional practice owners (especially dentists) in Oregon and along the West Coast. With a passion for simplifying finances, optimizing opportunities, and saving money, Steven provides customized wealth advisory and accounting services, including investments, income and estate tax planning and compliance, and retirement planning, so that his clients can stress less and feel more confident about reaching their goals.
Steven prioritizes his clients, building long-lasting relationships that make a significant impact on their financial lives. He graduated cum laude from Brigham Young University with a Bachelor of Science in Accounting and is a member of the Willamette Valley Estate Planning Council and American Institute of Certified Public Accountants. Outside of work, Steven enjoys spending time with his wife, Rachel, and their five children. You can often find him adventuring in the outdoors—biking, hiking, traveling, and swimming. In addition to the Willamette Valley, they enjoy the splendor of the high desert of central Oregon and lush beauty of the Hawaiian Islands. To learn more about Steven, connect with him on LinkedIn.