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Too Much Money In A 401(K) Or Traditional IRA To Retire Early?

If you want to retire early, but your taxable accounts are not sufficient to fund your retirement until 59-1/2 when you can tap your Traditional IRA without penalty, what do you do?

First remember that Roth contributions can be withdrawn tax and penalty free.

Still not enough to live on? Or you don't want to deplete your Roth so early?

One strategy for IRA withdrawals for an early retirement (and avoiding the penalty) might be to start doing a conversion every year of funds from Traditional IRA to Roth.

Each year you will need to live off of and pay the taxes from non-Traditional-IRA funds, otherwise you'll pay an additional 10% penalty. But after 5 years, converted funds are considered to be Roth contributions.

So if you have taxable funds to live on (or existing Roth contributions which can be withdrawn tax free), then the strategy would be to convert up to your tax bracket is full or a year's worth of expenses from Traditional to Roth. Pay the taxes and live on your taxable or pre-existing Roth contributions.

Then 5 years later, that converted amount will be considered as "principal" (or contribution) and can be withdrawn tax free.

If you repeat this conversion every year (into a different Roth every year), then in the 6th year you'll be able to start using the 1st year's converted funds. The 7th year you could use the 2nd year's conversion, the 11th year the 6th year's, etc.

This way you deplete your traditional IRA starting early, but at the rate you decide and sheltering the money into a Roth. But at the same time, creating a source of funds to live on outside of the Traditional IRA, without paying the penalty for early withdrawal.

It seems like it could work and comply with all the IRS rules...

If you don't have enough outside the Traditional-IRA to survive that first 5 years, this approach could also be used to minimize the penalties incurred withdrawing from your Traditional IRA. Whatever you live on in the first 5 years, still do at least some conversion so that in year 6 you'll have the 5yr old Roth conversion contribution available. At that point then you won't need to spend as much if any T-IRA money until the penalty expires at 59-1/2.