5 Ways To Retire Early

0:00Brian Preston:Hey Chicago, class it up with Crocs. You know back to school is coming in fast. So why wait to find your new fave footwear? Step into a local Crocs store and step into your new look. Try it. Style it. Make it yours. Because the right pair doesn't just show up, it shows off. First day fits, handled. Walk out ready for whatever's next. Visit your nearest Crocs store today. This episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome, that's new. It can help you with practically anything on the web, like restoring a vintage motorcycle from a 50-page restoration block, or finally break down that long article you've had open for weeks.

0:45Brian Preston:Gemini and Chrome is here for it. Ready to make anything online make sense? There's no place like Chrome. Check responses set up required, compatibility and availability varies 18+. A lot of people want to retire early, but how do you actually access the money when it's tied up in retirement accounts? Brian, I am so excited because today we're covering five ways to retire early, including some that you may not even know about. I'm Brian, he's Beau, and this is The Money Guy Show, where two financial advisors share strategies to help you grow your wealth and get access to it when you actually need it.

1:24Brian Preston:Yeah, Brent, a lot of people want to retire early, or at least they want the option to. They want to get to financial independence so that they then have the ability to own their time, to do what they want, when they want, and the way they want to do it. But let's face it, this system is designed for you to get access to your money after you're 59 and a half. So what do you do if you actually won't access to that hard saved money much, much sooner? And if you listen to us for any amount of time, you know, we talk about the financial order of operations all the time. Brian, you know the thing for me, we have a nine step process to help you figure out what to do with your next dollar.

1:59Brian Preston:And a lot of people say, okay, well, if I want to retire early, if that's what I want to do, then I probably need to break the financial order of operations or whatever that happened. Brian, is that true? No, I do not think you have to break the financial order of operations, but it is going to require you to kind of use all the tools that are in the tool belt of the financial order of operations. And with that, we're going to kind of give you all the different things you can do. Because first of all, if you're going to be going through the financial order of operations, we still want you saving in these retirement accounts that have a 59 and a half or 55 access point.

2:35Brian Preston:Yeah. So why are retirement accounts a big point for exactly that reason. There's a good chance that you're going to need these dollars even after age 59 and a half. We think so much about early retirement and what that looks like in our 40s and 50s, but there's a big chunk of our assets that we're going to need to optimize in our 70s, 80s, even 90s. So why not take advantage of the accounts that are designed exactly to do that? And we're going to show you today that there's actually easy ways to access these accounts earlier, then yes, you taking the easy shortcut of just opening up a taxable brokerage account.

3:09Brian Preston:So we're going to walk through five different ways that you can access your money that you may not know about. And the very first one is the one that you actually just said. This is utilizing a regular after-tax brokerage account. Now, look, we like after-tax accounts because these are still tax favored because we'll talk about what the dividends can be lower tax rates. Capital gains can be lower tax rates, but they don't get the tax deferred or tax free growth that you see with a lot of the retirement accounts. So it better make sense. You make sure you understand tax rates when we're talking about investing in this structure.

3:48Brian Preston:Yeah. So a lot of people will say, okay, I'm just going to do the taxable brokerage account. I'm not going to do the 401k or I'm not going to do the other types of accounts. Well, the reason you may be missing out on that is because historically, this is true now, and it's been true for the last 30 years, ordinary income rates are higher than capital gains rates. So if I can save some money today and I can save at the ordinary income level, that's likely going to be more advantageous to me than just saving in an after-tax account and being able to take of long-term capital gains. Yes, long-term capital gains are favorable and they are a tax advantage, but it's not more advantage than it's not more advantageous than actually saving money at the ordinary income tax.

4:29So let's talk about the benefits of using a taxable brokerage account because this is the easy button. If you think about it as, hey, let's go out and load up this after tax account, but look, we don't want you cutting the corner off. And that was the whole point we were making, but we can start with the pros of this is accessible for everyone. If you think about the fact that there's not any early withdrawal penalties, there's no contribution limits. this is one that really does make it easy.

4:55Brian Preston:Yeah, it has a ton of flexibility and the fact that you don't have to be working or not working in order to do it. You don't have to be a W-2 or a 1099 employee. There aren't contribution limits. There aren't age requirements. And we've already alluded to this. When you invest in an after-tax brokerage account, the gains on that when you go to sell the securities are taxed at long-term capital gains rates. They're not taxed at ordinary income rates, like the money that you pull out of your 401ks and IRAs. And this is what we were talking about earlier on the con side of this is that, yes, there are tax favorites parts of it, but it's just not as good.

5:30I mean, how do you actually compete with tax-free growth or tax deferred for the next 20 to 30 years? So that's what the part we want to cover is, yes, this might be a good bridge account and more to come on that. But we do want to make sure you understand that there are actually four other ways that you can get access to some of these more tax-favored accounts. And that's stuff we want you to lean into and pay attention for.

5:52Brian Preston:All right. So strategy number two, again, we've talked about this a little bit, but this is the rule of 55. And we won't spend a ton of time on this one because this one is actually pretty straightforward. What it suggests is that if you are employed with a company that sponsors your 401k or your employer sponsored retirement plan in the year that you turn 55, you can begin accessing those dollars penalty free before 59 and a half, but you have to make sure that you do not retire, do not leave work until the year that you turn 55. Yeah, this is one that it's rule of 55, not retire at 53, leave it in that account for two years and then pull it out.

6:28No, you have to literally be working at this company in the year that you turn 55 for this rule to actually work for you.

6:37Brian Preston:So how do you need to structure your accounts if you want to do this? Well, obviously you're going to be building inside of a pre-tax 401k, inside a traditional 401k where you get a current year tax benefit. If you decide to contribute to a Roth 401k, it can work, but you need to recognize that any dollars you go to pull out of your Roth 401k before 59 and a half, if any of them are earnings, they will be subject to taxes and penalties. So you can only pull out your basis in the Roth 401k. So the best setup, if you're going to take advantage of the rule of 55 is doing so inside of a pre-tax 401k.

7:12So let's go through on Rule 55, what are the pros and what are the cons? For the pros, this is pretty simple. I mean, it's a pretty binary decision of, hey, am I in the year that I turned 55 and did I have separation of service? If the answer is yes, hey, voila, you've unlocked. We have full access to immediate and full potential without having to pay an early withdrawal penalty.

7:34Brian Preston:And it's tax advantaged if your tax bracket's gonna decrease in retirement. If I put money into my pre-tax 401k when I was in the 30 % tax bracket, but then I retire at 55 and I'm going to be in the 22 % tax bracket, obviously that was a more advantageous tax arbitrage that I was able to take advantage of. Now, if we're talking about the cons of this, it is dependent upon the plan design. You have to, because when your company set up their 401k, they did have to make the election to choose to allow the rule of 55 to be something that they wanted their participants to have available to them. And the other limitation is this has to be with your current 401k, the actual retirement plan that you are currently participating in.

8:19Brian Preston:If you have an old 401k or an old 401k that you rolled into an IRA, where those assets are now would not qualify. But there is a little bit of a hack. There is something you can do if you know that you're going to retire and you do have other pre-tax assets or old 401ks or old employer sponsored plans. You can actually roll them into your current plan, thereby allowing you to access those dollars after you turn 55. But if you do not do that account consolidation, you do not roll them in, those other assets would not be available. And this last con, this is Captain Obvious stated this, is you can't retire until you're 55.

8:54Remember, this is rule of 55. If your goal is to retire at 50, this probably isn't for you.

9:01Brian Preston:All right. So we're talking about ways to retire early. And I don't know if we did this on purpose, but we're kind of going from least complicated to more complicated. Because obviously, taxable brokerage account, not all that complicated. button. Rule of 55, again, not all that complicated. You just have to turn a certain age before you access. Now, this third one, this is one that I do think is a little more complicated. And if you read any sort of financial independence or tire early literature or doing your research, you've likely come across 72T distributions. And if you don't love numbers, let's give you an acronym, SEPPS.

9:34And what that stands for is Substantial Equal Periodic Payments. This is actually a setup. I'll let Bo read the actual definition, but it's going to allow you to have access to these retirement plans earlier than that 59 and a half without penalties. You know what? You don't have to read it because I actually just gave it off of memory, pretty much the exact same definition.

9:52Brian Preston:Because I can read the thing that you just said if you want me to. I didn't realize I was going to get it so close to the actual definition. I don't do that very often. So how do you do this? How do you actually take advantage of substantially equal periodic payments or 72T distributions. Well, one, you need to choose what account you're going to do the 72T from. Is this from a 401k that you've been participating in? Is it from an IRA that you rolled a 401k into? Is it just from a pre-tax IRA? You choose a specific account that you want to subject to this type of distribution. Then you want to choose the type of payment.

10:23Brian Preston:And there are generally three different calculations you can do. You can do the RMD, required minimum distribution method, where every year, the amount of your payment is recalculated based on the size of the portfolio and your life expectancy. You can do the amortization method, which is a fixed amount where it equally amortizes the amount that you'll receive over a fixed period of time. Or you can do the annuitization method, which uses an annuity factor to calculate your payment based on your mortality rate, a chosen interest rate, and how much money you're starting with. Each of these three different calculations will come up with three different answers for how much the periodic payment is going to be.

11:04Brian Preston:So you want to make sure if you're doing this for early retirement, that you choose the right calculation method so that you can actually meet your retirement living expenses. Then once you set this in motion, you have to make sure that the payments continue for at least five years or until you turn age 59 and a half, whichever is longer. So if you were to start 72T at 57, you have to go past 59 and a half. If you were to start them at 45, you would have to execute them for 15 years. So you want to make sure your math is right before you jump in. So with that, as you can see, by the way, just by the sheer fact that you have to choose what your distribution method is, is a complication.

11:46Absolutely. And then the fact that you have to now make sure you honor this five year or 59 and a half, whichever is longer, you can quickly see how this gets complicated. And then let me tell you how this actually works in practicality. And then we're going to go through the pros and cons. A lot of times you're trying to get to a specific amount of money that you need in retirement. And you have this one big account. And if you calculate the payment off of that, you're like, whoa, that's way too much money. I don't want all that money. So you have to then split the account out. You have to go back into the much smaller account balance that you actually now want to make eligible to the 72T.

12:22You can quickly see how this thing spirals into a complexity that you probably had not originally thought of, but still it is a viable option if you are leaving the workforce early.

12:32Brian Preston:And so if you're thinking about this, is this something that makes sense for me? What are the pros and what are the cons? Well, obviously, one of the pros is while you're building up, while you're saving, the accumulation process is pretty straightforward. You follow the financial order of operations, you fund your pre-tax 401k account. And then when you get to retirement, when it's time for you to start taking these dollars out, that's when the complexity enters into the equation. They'll also have the tax advantage. If your tax rates go down because you're essentially not having as much earned income, they can be tax advantage because your tax brackets will decrease in retirement.

13:05Brian Preston:Now, as you can imagine, those are the pros, but there are some cons. And probably the first con is very obvious. There is a lot of risk in the complexity. The calculations on how much you should take can be difficult. And if you mess it up, the penalties can be pretty severe. If you either stop the payments prematurely or you do not take a substantially equal amount that you're supposed to take, they can actually charge you a 10 % penalty retroactively for all of the years that you were executing this strategy. So you want to make sure that you get this right on the front end and you actually execute it correctly.

13:38Yeah. And then realize these don't have a lot of flexibility in them. Once you kind of set it and forget it, you don't get to change things like the distribution method doesn't change. If you think about the fact that there's a lot of market volatility and now that payment you calculated doesn't work out to what you actually need to live off of, you have to start the process again with more of the previous account balance that you maybe had rolled an account off of. Or what happens if all of a sudden you have a, you set up this 72T and then you have a windfall of money coming your way, whether it's an inheritance or you start doing side hustle or you do other things, well, sorry, you started this process.

14:17You have to finish the drill because remember it's the longer of either five years or reaching 59 and a half. There's no take backs on that.

14:24Brian Preston:Yeah. I think what's really interesting as it relates to 72T distributions is they're super interesting from like an academic and theoretical standpoint. When it comes to practice, we really just don't see it all that often. And even for the people that are going to do 72T distributions, what they're likely going to do is they're going to open up that separate account. They're going to put a smaller sum of money in there, and it's only going to cover a portion of their needs. They basically create their own short-term fixed annuity to create that income stream. So for as much press and as much interest as 72T distributions get, I feel like in practice, I just don't see them really all that often across fire participants.

15:04Yeah. So that's 72. Still a viable tool though, because I do want to make sure we don't poo-poo it too much because we have clients that are using this strategy and using it effectively. We just want to make sure you go into it with your eyes fully open. When I started podcasting all the way back in 2006, a lot of other financial advisors thought I was crazy for giving away so much free advice.

15:23Brian Preston:And here we are 20 years later, still loading people up with free calculators and resources and financial education. And the reason is we really do believe in the abundance cycle. Yeah, we know a lot of you will use this information to help you build your wealth, and that makes it all worth it. But for some of you, that knowledge works a little too well. Your net worth grows, your financial life gets complicated, and one day you realize you need to take the relationship to the next level. And when that day comes, we would love for you to come back to where it all started. The Money Guy Show and Abound Wealth.

15:57That's right. We're fee only. And we're fiduciary advisors, meaning we put your interest first. And our goal is for you to rest easy knowing every box is checked in your army of dollar bills that they're working efficiently.

16:09Brian Preston:So if you're at that point, go check us out at aboundwealth.com or click the link below. We'd love to connect and see if we are a good fit for you. You know what? And that's what we always talk about, the abundance cycle. We help you build wealth for free. And if you ever need a professional to take you to the next level, we're right here and we'll leave the porch light on for you. So if 72T is one that gets a lot of press, this fourth strategy also gets a lot of press. And this is executing a Roth conversion ladder in order to be able to access your dollars early. Yeah. Now this one's interesting is because we all know when you start saving and investing, especially if you have an employer retirement plan, it's not uncommon that you look back one day because it's so tax favored and you go, man, I have a huge tax deferred retirement account, but I'm planning on leaving the workforce at 53 years of age.

16:56What am I going to do to get access? And then there is an option where, and I think I love that the FIRE community or the retire early or move on to the next endeavor community has said, hey, there is a loophole in the fact that if you do a Roth conversion and you turn some of that 401k or that rollover IRA and convert it into a Roth, if you keep it out there for five years, you can actually get access to that money even if it's before 59 and a half, because that's now basis.

17:25Brian Preston:That's intriguing. That's right. A lot of people don't recognize one of the little known things about Roths is even though they're supposed to be used for retirement and 59 and a half, any money that you put in, any money that you contribute is considered basis that you can access pre 59 and a half with no tax and no penalty. Well, when you're doing Roth conversions, exactly what Brian said, now you're just adding to the basis. So what are the logistics? How does it actually work? Well, step one, you contributed into your 401k. And this year you can contribute up to$24 ,500 into the pre-tax traditional side of your 401k.

18:00Brian Preston:Hey, Chicago, class it up with Crocs. You know, back to school is coming in fast. So why wait to find your new fave footwear? Step into a local Crocs store and step into your new look. Try it, style it, make it yours because the right pair doesn't just show up. It shows off. First day fits, handled. Walk out ready for whatever's next. Visit your nearest Croc store today. This episode is brought to you by Google Chrome. You think you know a browser, but Gemini and Chrome, that's new. It can help you with practically anything on the web, like restoring a vintage motorcycle from a 50-page restoration block, or finally break down that long article you've had open for weeks.

18:44Brian Preston:Gemini and Chrome is here for it. Ready to make anything online make sense? There's no place like Chrome. Check responses set up required compatibility and availability varies 18 plus. Then as you get closer to retirement, you choose to convert a portion of that 401k to Roth. You're going to pay taxes on the converted amount and then that becomes part of your Roth basis, but you have to let it sit in there for five years. You can't convert today and then draw money next year. You have to let it season. If you let it season, then you can draw penalty free and tax free. And you repeat steps two and three annually for as many years as you need to create distributions for.

19:23So let's take an example here, a visual example of somebody who's taken years and decades to save and invest and have built up a traditional 401k. And then they determine, hey, five years from now, I think that the amount of money I need to kind of bridge my early retirement is$30 ,000 a year. So what they'll do is, is five years from the day that they actually think that they want to retire, like say in this example, 2024, when they're 50 years of age, they're going to convert$30 ,000 into a Roth. Now they're going to wait the five years. So in 2029, they will now have access to that$30 ,000 because they waited the right holding period.

20:03Now they have access to what's in the government's eyes, the basis in this Roth conversion. And then they'll repeat that process for when they're 51, 52, 53, 54. And you'll see that this is actually going to be the bridge account that's going to fund$30 ,000 a year is available to them all the way until they're age 60, which ding, ding, ding. Now you're north of the 59 and a half and have access to all of your retirement.

20:27Brian Preston:So just initially, this seems interesting and we love the idea of turning. what is that? One, two, three, four, five, six,$180 ,000 into Roth dollars. But here's the issue. Every year that you were converting from age 50 to 55, you had to pay tax on that conversion. So $30 ,000 got it added to your ordinary income tax. And then you began drawing off that Roth basis in years 55 through 60. What I'm going to argue is that if you had money to pay the taxes on the conversion, you probably could have built an after-tax account instead of doing the Roth conversion. I can't help myself. I got to throw it out there.