Want to Retire Early? Plan for First and Second Retirements
Do you want to retire early and live the life you've always dreamed of? Then you know that the key to success in this endeavor is advance planning and strategy. One of the most important strategies you can use is the two-step retirement plan. What is a two-step retirement? And how can you prepare for it? Here's what you need to know.
Step One: The First Retirement
Any time you want to retire before the standard age, you need to plan for a 'first retirement' with different rules. This first retirement could be just a few years or it might be more than a decade depending on your retirement age goal.
Why should you think of these years as a 'first retirement'? The answer is due to access and taxation. Most retirement accounts — including 401(k)s and traditional IRAs — penalize a person who takes out money before the designated age. The IRS, for example, may impose an additional 10% tax on IRA withdrawals before age 59 1/2. That's on top of your regular federal and state income tax.
In the case of pension plans and Social Security, you may not even be able to get access early — which could be an even bigger obstacle. And you need to plan for a gap between employer-provided health insurance and the age at which you can apply for Medicare.
All this means that you will need to find a way to access your money consistently — and without penalty — for the first years of your retirement. Many early retirees use taxable investment accounts to fund these years.
But you can save on taxes if you use tax-advantaged investments including tax-exempt (municipal) bonds or U.S. Treasuries. A Roth IRA can help as well since it has no penalty for early access.
There are a few other ways to create a first retirement nest egg. Look for work within an organization that allows younger retirees to access their pensions before the traditional ages. Or, store your nest egg in a nontraditional, safe investment vehicle that minimizes taxes.
Step Two: The Second Retirement
Compared to the first part, the second retirement is much more normal. At this point, you would shift from those early income methods to more traditional retirement accounts as you age into them.
Depending on how much you need from it, apply for Social Security any time between the early date for your age bracket and the latest date at which benefits increase. If you have significant other income early on (including leftovers from your first retirement), you may want to hold off on Social Security in order to build up a larger monthly payment and prevent unnecessary taxation of your benefits.
If you have a traditional pension and retirement accounts, access these in the best order for tax purposes. If you own a Roth IRA, for example, you have already paid the taxes on this income, so you can use it first with no tax consequences. This allows you to more slowly use tax-deferred accounts like a regular IRA, spreading out the tax impact and keeping your effective rate lower.
Where to Get Help
Planning for taxation during both your first and second retirements is a challenge. Most average savers don't know the ins and outs of the Internal Revenue Code, after all. So your best chance for success is to work with an experienced tax planning attorney as well as an accountant. They can help you consider all your options, compare your goals, and learn the best ways to deploy your savings.
At Donald B Linsky & Associate PA , our tax planning pros are ready to help. Call us for an appointment today and start turning your early retirement dreams into reachable goals.
