Retired Military Finances 401: I Want My Money Now!Retirement Funding Taxes
No this isn't an article about someone buying your court settlement. It has to do with another situation you may run in to and it could go something like what happened to a Marine Gunny I was talking to a few years ago. I had finished teaching a class at an ETAP at Camp Lejeune and the Gunny came up to me and said he wanted to start a franchise in retirement and all of his assets were in TSP. Now in his case he needed a lot of capital up front and there was a solution for him. But what if you want to retire, retire early (before 59 1/2) and need to access your retirement funds? There may be some options.
The Age 55 Rule
If all your money is in TSP, this probably won't apply to you unless you're a G.O. or Flag Officer or you work as a government civilian. But the Internal Revenue Code (IRC) allows those who leave a company in or after the year they turn 55 to access funds in that employer's retirement account (think 401(k)) and avoid he 10% penalty for early withdrawals. You will owe taxes on the withdrawals though. So, if you start a second career after your military retirement and work until age 55 or older, you'll have this option. You can also screw up this option by rolling your employer funds into an IRA or TSP. If this could be an option you want to use, make sure you leave your employer's retirement accounts alone.
IRC Section 72(t)(2)(iv) allows you to take distributions without penalty if certain rules are followed. These distributions are commonly called 72(t) distributions. At the basic level the distributions must be a series of substantially equal payments made for the life expectancy of the employee or joint life expectancies of the employee and designated beneficiary (employee in this context is the person who set up the account...since you may be retired, retired). But as all things with the IRS, there are rules.
- Once the distributions begin, they must continue for the longer of 5 years or until the account owner reaches age 59 1/2.
- Payments cannot be modified (with one exception) or stopped without incurring significant penalties
- The amount of the payment can be calculated by using one of 3 methods (explanation of calculations is beyond the scope of this article)
- RMD methodology
- Amortization methodology
- Annuitization methodology
- Changes to the account balance can only occur due to investment gains or losses and the distributions. That means you can't make deposits to the account
- You are allowed a one-time change in methodology from amortization or annuitization to RMD methodology. You can't change back
- Unlike other situations such as Roth conversions, in this case you can segregate your IRA accounts and only take the 72(t) distributions from one account
Don't Forget Your Roth Account
While I don't really recommend this but if you don't want to sign up for 72(t) distributions, you might be able to get enough funds from your Roth IRA to provide the income you need. This is due to the ordering rules on Roth distributions. The first money to come out of your Roth IRA is your contributions. Since those funds have already been taxed, there is no tax or penalty on the distribution. After that, distributions are credited against any converted amount and these funds may also be tax and penalty free. Once you hit your earnings, then the early distributions are subject to taxes and penalties. It may work for you, but I'm not a huge fan of this option.
Military Finances are Different
While 72(t) conversions are available to all taxpayers, most taxpayers don't start their first retirement in their forties or fifties. Retired military finances are different than finances for civilians. That's why we think you should work with a financial advisor that works with people like you every day. We've been where you are. Give us a call or use the button below to schedule a meeting to talk about how we might be able to help you.
If you found this article useful, you might like the following blog posts:
If You Get the VA Funding Fee Refunded, Do You Pay Taxes on It?
Military Finances 301: The 10-Year Real Estate Suspension
Watch Out for this TSP Tax Trap