7 Keys To Funding Early Retirement Before Touching Your 401(k)
Retiring early doesn't have to mean tapping into your 401(k) right away. In fact, many early retirees spend years funding their lifestyle before doing so.
The good news is there are several ways to bridge that gap, from taxable investment accounts to Roth strategies and other withdrawal options.
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Here's how to fund early retirement before tapping into 401(k) savings.
1. Stress Test Your Budget
Before deciding how to fund early retirement, it's important to determine whether the numbers work in the first place.
Jacob Bayer, a financial advisor and founder of Jacob Bayer Wealth Management, recommended living on a retiree's budget for six to 12 months before leaving the workforce. Doing so can reveal overlooked expenses while providing a realistic picture of what monthly spending might look like in retirement while still collecting a paycheck.
“Nothing on a budget spreadsheet is as valuable as truly living the budget,” Bayer said.
2. Understand the Bridge Years
Retirement may be financially possible, but funding it requires more than simply leaving the workforce. Depending on when retirement begins, tapping 401(k) savings too early can trigger taxes, penalties and other long-term consequences for a retirement plan. Financial planners refer to this time as the “bridge years.”
“The bridge years are critical because retirees need income while many retirement accounts still carry early-withdrawal restrictions,” said Christopher Stroup, a certified financial planner and founder of Silicon Beach Financial.
Stroup said the biggest risks for early retirees during the bridge years were market downturns, underestimating healthcare costs, and paying more taxes or penalties than necessary.
3. Start With Taxable Investment Accounts
Taxable investment accounts are often one of the first places financial planners look when helping clients fund early retirement.
Stroup said that many early retirees benefit from using taxable brokerage assets first while strategically converting portions of traditional retirement accounts to Roth accounts during lower-income years.
“The optimal order depends on tax brackets, cash-flow needs and long-term estate planning goals,” he said.
4. Consider a Roth Conversion Ladder
A Roth conversion ladder is another strategy some early retirees use to fund the years before tapping 401(k) savings. It involves gradually converting money from a traditional retirement account to a Roth IRA over multiple years rather than all at once.
The strategy requires advanced planning. The IRS has specific rules governing Roth IRAs, including five-year holding period requirements that may affect when converted funds can be withdrawn without penalties.
Since Roth conversions can affect taxable income and have other tax implications, early retirees may want to consult a financial or tax professional before making conversion decisions.
5. Explore Rule 72(t) Payments
Rule 72(t), also known as substantially equal periodic payments (SEPP), is another option that can provide penalty-free access to retirement accounts before age 59½.
“Rule 72(t) SEPP is often the most misunderstood,” Stroup said. “It can provide penalty-free access to retirement accounts before age 59½, but it requires a rigid withdrawal schedule that generally must continue for at least five years or until age 59½, whichever is later.”
Stroup added that improperly modifying or stopping those payments can trigger retroactive penalties and interest.
6. Don't Overlook Healthcare Costs
Healthcare costs are often one of the most overlooked expenses in retirement planning.
“The most difficult period to estimate is retiring before age 65 and the start of Medicare,” Bayer said. “The cost of health insurance can easily be $1,000 per month to cover two people.”
For those who are eligible, a health savings account (HSA) can help cover qualified healthcare expenses during retirement. HSAs offer tax advantages that can make them a useful tool for planning healthcare costs alongside other early retirement funding strategies.
7. Know the Tax Implications
Early retirees may want to consider the tax implications of a funding strategy before deciding which accounts to tap first. Capital gains taxes, state income taxes and Roth conversions can all affect how much money remains available during the bridge years.
Stroup said focusing only on avoiding the 10% early withdrawal penalty can cause early retirees to miss the bigger picture when planning for the bridge years.
The Bottom Line
Retiring early without tapping into 401(k) savings may seem like a big goal. However, it’s not.
With the right plan, the bridge years can become an opportunity to build a retirement timeline that reflects personal goals, spending needs and financial priorities.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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