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Hacking Your 401K Withdrawal Penalty: A Guide

Can I use my 401(k) to retire early and avoid the 10% withdrawal penalty? – Jesse, Boston

It is possible to use your 401k to retire early, but you have to hack it. It’s important to understand how you can use your 401k to reach your retirement goals in order to maximize its potential. When I turn 35, I plan to take a break from work for a while. The best way to save money for retirement is through a 401(k) plan, and most young people who work in corporate jobs have access to one. Matching contributions to 401(k) plans are attractive to young people who want to maximize their retirement savings. You can put money in before having to pay taxes on it, and most employers offer a matching contribution, so they put additional money in for free. You can decide how much you want to put in each month.

You should put as much money into your 401k as possible as soon as you can. As of 2015, you can contribute up to $18,000 per year. It is possible to save up to $54,000 over three years. This is your biggest retirement savings opportunity if you put in enough money. The more potential your retirement savings have to increase, the sooner you can take advantage of this opportunity. Your future self will thank you if you make a sacrifice in your lifestyle. Over the past 5 years, I have put in the max into my 401(k) and the money has grown considerably. I’m proud of the financial choices I’ve made and I look forward to using my 401k funds in retirement. It makes your income look smaller to the IRS because you don’t have to pay taxes on this money.

But there are a number challenges with 401k’s:

  1. They typically have much larger fees than other types of retirement investments
  2. You have limited investment options – you are restricted to investing only in the funds that are available in your employer plan unlike a You can choose your IRA investments.
  3. You are penalized 10% if you take the money out before you are 59.5 years old (that’s a long time from now)

How can you use your money to retire early? One of the best ways to make early retirement possible is to maximize your contributions to your 401(k) and take advantage of any employer matching programs.

5 steps to withdraw 401k funds without paying a penalty

You don’t have to pay an early withdrawal penalty if you hack your 401(k) so long as you stay in your job. Before making any decisions, it is important to understand the implications of taking money out of your 401k early and weigh the pros and cons. If you leave your job and don’t keep it, you can take a loan from your 401(k) and avoid the penalty. It is important to understand the implications of taking a loan from your 401(k) and that it should only be done as a last resort. So if you are a Millennial and want to retire early using your 401k your options are much more limited – but there is still a solid “hack” around the penalty, but it is not well known.

The most effective way to use your 401(k) to retire early is to set up regular IRA payments that can be taken without a penalty. Even though you don’t have to pay the 10% penalty, you will still have to pay taxes on the withdrawals based on your current tax brackets. It is relatively easy once you understand the basics of how it works. It’s worth taking the time to learn how it works, as you will find that it can be useful.

1. Convert your 401k into an IRA

When you leave your job and are ready to “retire” convert your entire 401k plan into a Traditional IRA (individual retirement account). Unfortunately, you need to convert your 401k into a Traditional IRA instead of a If you haven’t paid taxes yet on the money, you’ll be able to open a rk IRA. When you withdraw money from the IRA, it is tax free.

2. Set up an SEPP plan to take penalty free 40k withdrawals

Once it’s in an IRA, you are legally allowed to set-up and take what is noted in the tax law as “substantially equal periodic payments” or SEPPs from the IRA that you just created using your 401k. You have to take equal withdrawals for 5 years or until you reach 59.5, whichever is longer. Before taking money out of your retirement account, you should consult a financial advisor. It will be until you are 59.5 and not the 5 years. Before you can retire, you will have to work longer than your parents and grandparents did. This can take a long time, but will eliminate the 10% early withdrawal penalty. There may still be taxes associated with early withdrawal. You only have to take 1 withdrawal per year. The withdrawal must be taken by the end of the tax year.

3. Calculate your payments

After setting up and SEPP you need to figure out how much money you need to take out each year.
Here are 3 IRS approved ways to calculate your periodic payment amount:

  1. Required minimum distribution (RMD)
  2. Fixed amortization
  3. Fixed annuitization
SEPP Calucation Methods – © The Vanguard Group Inc.
If you choose this method… You will…
Required minimum distribution
  • The smallest amount of the 3 methods is usually received. This means that those who choose this method will have to find other sources of income.
  • Receive an amount that changes yearly. To make sure you have enough money to cover your expenses for the entire year, you should budget accordingly.
  • Use the easiest calculation–but you’ll need to recalculate your payment each year
Fixed amortization
  • If you want to get a larger annual amount, use the RMD method. Those who choose to use the fixed annuity method will be able to generate more income over time, as they will generally receive a larger annual amount than with the RMD method.
  • Each year, you will receive a fixed amount.
  • Use the most complex calculation–but you’ll only need to calculate your payments once
Fixed annuitization
  • If you want to get a larger annual amount, use the RMD method.
  • Each year, you will receive a fixed amount. You can use your fixed amount to supplement your income or save for the future.
  • Perform the calculation only once

For young investors who want to retire early, it’s a good idea to take your age and subtract it from 59.5 to calculate what distributions you should take. To figure out how much I should withdraw from my IRA, I need to divide the total value by 2. Fees or taxes that may be associated with the withdrawal should be taken into account. If you are planning to set these up, I recommend that you call the company that holds your IRA to find out what the best payment strategy is for you. It is important to know that your IRA payments will have a direct and significant impact on your retirement savings, so it is essential to make an informed decision.

I recently called Vanguard, which is where I hold my own investments and they were able to easily to connect me to someone who could help me calculate what my own withdrawal could be based on my current IRA investment.

4. Split your IRA account to isolate funds for withdrawal

To make it easier, some tax professionals recommend that you split your IRA account so that one part holds your payouts and the other part doesn’t. By splitting your IRA into two parts, you can better plan and budget for your retirement while still allowing some of your investments to grow over time. I plan on putting my planned withdrawals into one investment in my IRA and then the longer term growth money into another investment type, both of which can live under the same IRA account. To ensure that I am making the most informed investment choices, I will consult with my financial advisor before making any decisions. convert your 401(k) into an IRA and split it into two parts, one containing your planned payments and the other your growth investments. If you split the IRA, you can adjust your planned payments/withdrawals and growth investments to ensure that your retirement goals are met.

5. Continue to invest in your IRA when you can

If you want to retire early, you should leave your investment accounts alone, but you should try to leave your 401k and IRA money untouched as long as possible. It is advisable to research the tax implications before withdrawing funds from savings accounts. Even though you are taking distributions, your investments will continue to grow in your IRA. I plan on taking distributions and adding to the IRA account during this time period so that I can use money in my 401(k) as needed in my early-retirement. I’m confident that this strategy will help me reach my goals of financial independence while still allowing me to enjoy my retirement years.


To learn more about this 401k “hack” to avoid the early withdrawal penalty check out the IRS page on SEPPs.

This is part of my own personal plan that I intend on using to retire early, so please remember that I am not a taxplanner or financial advisor. Before making any major decisions about your finances, you should do your own research and consulta financial professional. I encourage you to consult a registered and licensed tax professional if you want to discuss your own SEPP plan. SEPP plans are complex and require careful consideration of your individual financial circumstances. If you have any questions in the comments, please let me know.

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