Early Retirement Distributions

A taxpayer may choose, or be forced into choosing, early retirement. A retirement before age 59½ creates income challenges for the retiree. The retiree is not yet eligible to receive retirement benefits from Social Security. The retiree may or may not have a monthly pension to generate income.

In many situations, the retiree will need to generate income from his or her assets. Often, the retiree has most of his or her assets in a retirement plan through a 401(k) plan at his or her employer or in an individual retirement arrangement (IRA). Withdrawals of earnings and pre-tax contributions are subject to ordinary

income tax. In addition, taxpayers may be subject to the 10% early withdrawal penalty tax on distributions taken before the taxpayer reaches age 59½.

Tax Summary

•    Withdrawals of earnings and pre-tax contributions from an IRA are subject to ordinary income tax.

•    Unless an exception applies, taxable withdrawals from an IRA prior to age 59½ are subject to a 10% early withdrawal penalty.

•    Taxpayers who take a series of substantially equal pe-riodic payments from an IRA are not subject to the 10% additional tax.

Tax Planning Strategy

One strategy to generate income from retirement accounts for taxpayers under age 59½ is to take periodic distributions from those accounts. If structured properly, the 10% additional tax will not be assessed on the distributions. Taxpayers can take distributions from various retirement accounts such as 401(k) plans, 403(b) plans, and IRAs.

Possible Risks

•    The rules for distributions using the Internal Revenue Code provide very little flexibility. Once the distribution begins, taxpayers need to exert extreme caution in making any changes to the distribution amount and frequency.

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