View from Koko Head, Oahu
After rolling over my 401(k) into an IRA, I’d like to focus on potentially the single most beneficial reason why everyone should convert their 401(k) into an IRA after they leave their jobs: Rule 72(t).
Rule 72(t) allows for penalty-free withdrawals of your IRA account before the age of 59.5 provided that the IRA holder take at least five “substantially equal periodic payments” (SEPPs). The amount depends on the IRA owner’s life expectancy calculated with various IRS-approved methods.
Three IRS approved methods to calculate SEPP:
1) Required minimum distribution method: This method takes your current balance and divides it by your single life expectancy or joint life expectancy. Your payment is then recalculated each year with your account balance as of December 31st of the preceding year and your current life expectancy. With this method, your payments will change depending on your account value.
2) Fixed amortization method: This method amortizes your account balance over your single life expectancy, the uniform life expectancy table, or joint life expectancy with your oldest named beneficiary. Such a method is more stable.
3) Fixed annuitization method: This method uses an annuity factor to calculate your SEPP. It’s hard enough calculating life expectancy and portfolio performance, let alone forecast interest rates for annuities so let’s skip this method.
The most common withdrawal calculation method is #1. I’d like to use my example for how using Rule 72(t) can help an early retiree extract more income and lead a more comfortable financial life.
The quick answer to how much you should have saved by age 45 is 8X your annual expenses. In other words, if you spend $50,000 a year, you should have about $400,000 in savings. Your ultimate goal is to achieve a 20X expense coverage ratio in order to retire comfortably.
Congratulations for reaching 60! You can now withdraw from your 401k penalty free if you wish. And if you aren’t 60 yet, then hang in there. The above average 60 year old should have at least $800,000 in their 401k if they’ve been diligently saving and investing.
