Question on retirement account early withdrawal penalties?

A retirement planning tool is only as good as its assumptions and inputs. Share your thoughts or ask questions about the internals of the simulation, built in planner assumptions, or planner inputs.
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frp user
Posts: 65
Joined: Fri Feb 29, 2008 12:55 pm

Question on retirement account early withdrawal penalties?

Post by frp user »

Thank you for making this program available.
I find it extremely useful.

One thing that doesn't seem quite right.
I noticed in the documentation that you state
that a 10% penalty is taken out by the program
if retirement funds are used prior to age 60.

I believe that rule only applies if you are withdrawing
the funds from a retirement plan while you are still
working. If you are retired, I think the correct
age is 55, not 60. Perhaps this depends on the
retirement plan, but I think this is the rule with
my retirement plan. Not sure how to get around
this problem with your program.

Thanks again.

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admin
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Re: Question on retirement account early withdrawal penalties?

Post by admin »

I'm glad you're finding the planner useful.

I'm not an expert on retirement plans, but for standard 401k and IRA plans in the US, I think the rule is 59 1/2 years old for penalty free withdrawals. There is a twist that says if you begin a series of "substantially equal" payments that would deplete the account based on your life expectancy, you may be able to avoid the penalty.

If I'm wrong about this, the simplest way to offset the effects of the penalty would be to go to the "Additional Inputs" tab and create an entry that reduces the income tax rate for the years between age 55 and 59 by 10%.

(Note: I'm not a tax expert of any kind, so take my comments as those of an amateur)

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admin
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Re: Question on retirement account early withdrawal penalties?

Post by admin »

Hello again,

It looks like I stand corrected on the age 55 rule. Here's what I found on 401k withdrawals at age 55 from a quick google search. This is from the retire early website (there are many other sources as well).

You can make penalty-free withdrawals from a 401(k) at age 55. You must wait until age 59 1/2 to make penalty-free withdrawals from an IRA. While this seems like a big break for a 55-year-old retiree, there are several things to consider; (1) Your employer must make it convenient for an ex-employee to make retirement withdrawals, many employers can't be bothered, (2) Rolling over your 401(k) funds to an IRA may increase the variety of investments available to you and lower your fees. If that's the case, the hassle of SEPP withdrawals from an IRA may be worth it.

Note: There is one fine point that many people miss in taking penalty-free withdrawals from a 401k at age 55. To do so, you must terminate your employment no earlier that the year in which you turn age 55. (See IRS Notice 87-13) If you retired at age 54 and waited until age 55 to make withdrawals from your 401k, you would not be able to make unlimited penalty-free withdrawals. You could only make penalty-free withdrawals by using SEPP.

Source: http://www.retireearlyhomepage.com/wdraw59.html

frp user
Posts: 65
Joined: Fri Feb 29, 2008 12:55 pm

Re: Question on retirement account early withdrawal penalties?

Post by frp user »

Jim,

Thanks for you speedy response. It sounds like there needs to be another option in the program to handle these different situations.

I tried the trick of reducing the income tax rate by 10% as you suggested.
That didn't work as I expected. I reduced my rate from 25% down to 15%, but it did not completely offset the early withdrawal penalty that was programed I could see this if I looked at the year by year withdrawal rates in the Detailed Output tab. I had to reduce the rate all the way to 4.5% to get the withdrawal rates in the 55-60 years to equal the >60 year rates. Maybe some sort of compounding is going on.

But it does do the trick. Thanks for the suggestion. By the way, I've tried the program on both a Mac and a Linux machine and
the program works great. For some reason, the table titles are don't show up on the Mac, but otherwise it works fine.

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admin
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Re: Question on retirement account early withdrawal penalties?

Post by admin »

It sounds like there needs to be another option in the program to handle these different situations.
Agreed. This will also be helpful for non-us users as well. It's definitely on the to-do list. Thanks for writing to let me know about this new twist (new for me) in the 401k rules.
I tried the trick of reducing the income tax rate by 10% as you suggested. That didn't work as I expected. I reduced my rate from 25% down to 15%, but it did not completely offset the early withdrawal penalty that was programed I could see this if I looked at the year by year withdrawal rates in the Detailed results tab. I had to reduce the rate all the way to 4.5% to get the withdrawal rates in the 55-60 years to equal the >60 year rates. Maybe some sort of compounding is going on.
This didn't sound right, so I took a look at the code and I'm embarrassed to report that I found a bug. I was basically calculating the taxes and the penalty twice in the case of early withdrawals from a regular IRA or 401k. Taxes on regular withdrawals and on early withdrawals from a roth were correctly computed.

I fixed this bug (in help, new version shows 1.0.7), so you shouldn't have to make the fudge it now. I didn't add an option to adjust the penalty age yet because that change requires some GUI work and is a bit more involved (I'm not sure where to put the option!).
But it does do the trick. Thanks for the suggestion. By the way, I've tried the program on both a Mac and a Linux machine and the program works great. For some reason, the table titles are don't show up on the Mac, but otherwise it works fine.
Thanks for this info. I tried the program on Linux a while back and the formatting was rough, maybe they've made some fixes to the Java system since then.

The issue with tables on the Mac is surprising because I thought everything looked good a while back. I probably adjusted some layout at some point and in doing so, broke the Mac. Java and web are obviously better than having to rewrite the code for each machine, but each system seems to have its own quirks. I'll take a look at the Mac issue and see if it's anything obvious.

Thanks again for all the help, and please let me know if the updated planner code works as you expect.

Regards,

Jim

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admin
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Re: Question on retirement account early withdrawal penalties?

Post by admin »

I posted another update that allows you to set the minimum penalty-free withdrawal age. It turned out much easier than I thought it would be. For some reason I thought I'd have to rework the layout, but it fit in nicely.

I also made another change to the early withdrawal penalty logic that should fix the issue you were seeing. I had taken a short-cut in computing the compounded tax/penalty rates and the error in the calculation was bigger than I thought. When computing withdrawal amounts, I have to withdraw enough to cover the spending and the tax and any penalty on the withdrawal. So if you need $50k and the tax rate is 25%, you have to withdraw $66.6k. The formula to figure that out is pretty computationally intensive (I think it's called a power series). Now I pre-compute and store more precise compounded rates, including penalty rates, just in case they're needed.

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