WCI #16: Understanding The Age 59 1/2 Rule

This is the White Coat Investor Podcast where we help those who wear the white coat get a fair shake on Wall Street. We've been helping doctors and other high income professionals stop doing dumb things with their money since 2011. Here's your host, Dr. Jim Dahli.

Welcome to podcast 16 what you need to know about the age 59 and a half rule. Thank you for being a White Coat Investor podcast listener. We're having a lot of fun with this. Actually, I'm having a lot of fun with this Cindy who does all the technical for it, she's having a bear of a time. It's amazing how much work goes into this. So while you may only listen for, you know, a few minutes per episode, there's a lot of work that goes behind the scenes in putting together a podcast. I've been very surprised how much it is. So thank you to Cindy for all your hard work that you've been doing.

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We've recently announced the White Coat Investor Scholarship for 2017, and this is something we've been doing now. This will be the third year that we're really excited about. It's a chance for us to pay some of the success we've seen forward and to really make a direct difference in the lives of a few medical students every year by literally giving them a pile of cash so they take out less in student loans as they go through medical school. But more importantly, the project helps spread financial literacy throughout our country's medical schools. And I think that's probably the most significant contribution it makes. But I want to make a special thank you to our platinum level contributors who have contributed at least $3,500 or more to the scholarship for this year. And they include Larry Keller with Physician Financial Services, Darian rewiten Bank or DRB that does student loan refinancing. Michael Relvis at Mr. Insurance locumstory.com and Jamie Fleischner at Set for Life Insurance, who sponsored this podcast. If you'd like to apply for the scholarship, we're taking applications@scholarshiphitecoatinvestor.com you can get more information on it by going to whitecoatinvestor.com scholarship. But basically all you have to do is submit a thousand word essay on anything you like and you have to be a full time professional student in good standing. That can be medical, dental, Pennsylvania, np, Pharmacy, anything like that. No undergraduates and no residents. But we're looking forward to seeing the submissions from this year and looking forward to getting a lot more white coat investor readers and podcast listeners involved in being volunteer judges. So if you would like to contribute to the scholarship, you can also do that@whitecoatinvestor.com scholarship. If you would like to volunteer to be a judge, you can also do that again, you send an email saying you'd like to be a volunteer judge to scholarshiphitecoatinvestor.com Today's post is really aimed at those who are interested in retiring early, and today I'm defining that as earlier than age 59 and a half. The only interesting thing about age 59 and a half is that is the age that the government uses to stop assessing penalties on withdrawals from retirement accounts such as 401ks, Roth IRAs, etc. So the question I get from time to time is should I invest preferentially in a taxable account so I have something to spend before age 59 and a half? Well, the truth of the matter is, if you've been saving enough money that you're actually eligible to retire before 59 and a half, you probably have a taxable account anyway because you've had to save more than you could fit into your retirement accounts unless you have a very advantageous retirement account situation or you're a particularly low spender. So this really isn't a big deal for a lot of people because they end up having a taxable account anyway. But there are many exceptions that allow you to get to your retirement account money before age 59 and a half without having to pay a penalty. For instance, if you have unreimbursed medical expenses that are greater than 7.5% of your adjusted gross income, you can take that money out of your retirement account penalty free. Now remember that your adjusted gross income after you retire may not actually be all that high. You can also, if you've been unemployed and collecting unemployment, take an amount out equal to what you're paying for your medical insurance. That's a relatively new one that's only been around for a few years. If you become disabled, you can take money out of your retirement accounts penalty free. You can also do it if with an inherited ira. For example, if your father leaves you his ira, you can take that money out before you get to age 59 and a half qualified. Higher education expenses for you or your kids, your grandkids can also come out of the the retirement account penalty free. You can also pull money out to buy a first home. And bear in mind what the IRS definition of a first home is. It's one you haven't. When you haven't owned a home for the last two years and you buy one that's a first home. But the cool thing is it doesn't have to be your first home. It can be your kids first home or your grandkids first home. See how that works? You, you pull $10,000 out of your IRA to pay toward their home and they gift you $10,000 for Christmas. No 10% due. Is that ethical? Well, perhaps not. Is it legal? Certainly. Just keep in mind there's a $10,000 limit for that one. If you're unfortunate enough to have an IRS levy, you can pull that money out of your IRA penalty free. Also, a military reservist can withdraw money while activated without paying the 10% penalty. Bear in mind also that these limitations don't necessarily apply to 401ks. Depending on the rules of the 401k, if you separated from the job and you're at least 55, not 59 and a half, you may be able to pull that money out penalty free and spend it on anything you like. This also doesn't apply to 457 accounts, which are really deferred compensation because that money doesn't technically belong to you, it belongs to your employer. That's good money to spend early in retirement anyway. And the fact that you can do so penalty free is just icing on the cake. Of course, you can always pull out HSA money for health care expenses without having to pay any penalties. And you can borrow against any of your assets without having to pay any penalties. You can borrow against your house, you can borrow against your 401, you can borrow against your life insurance. And all of that is of course penalty free. In the worst case scenario that you actually need to spend your retirement account money before age 59 and a half, you can still get to it penalty free. You just have to follow what's called the SEP rule. Sepp, Substantially Equal periodic payments. And what that means is that according to your age and basically an actuarial table, it tells you how much of your account you can pull out each year and you have to take out that same amount until you reach age 59 and a half or for five years, whichever is longer. And so the amount that is usually works out to be about the amount you should be withdrawing anyway. You know, the maximum amount you should be withdrawing if you want your money to last throughout retirement. So it's, you know, 3, 4%, that amount of money what you're required to take out. And so that works out pretty well for those who want to retire anyway. The truth of the matter is the age 59 and a half rule is designed not to prevent early retirement, but to prevent you from pulling the money out and blowing it all on a sailboat, that sort of a thing. And so if you're really just retiring early with it, it's really not that big a deal to just follow the rules and SEP that money. If you don't want to take out that 3 or 4%, you can take out less. You do it by just dividing up the IRA and splitting it into a couple of IRAs and then applying the SEP rule to only one of those IRAs. You don't have to apply it to all of your IRAs. So that's a good way to work around it if you only want to take a little bit out each year. And then, of course, since you're in a much lower tax bracket upon retiring, you can always just pay the penalty. It's not the end of the world to pay an extra 10% on that money. Coming out, a related question I sometimes get is, should my taxable money earmarked for my pre 59 and a half years have a less aggressive asset allocation? Because that time period is closer to me than the time period after age 59 and a half. And here's the way I look at it. All the money you have designated for retirement should be looked at as one retirement portfolio. And so let's think about what the consequences are if you're taking, you know, a little bit more risk in that taxable account and the risk actually shows up? Well, maybe your taxable account runs out a little bit earlier than it otherwise would. That's not the end of the world because you have, you know, the same overall asset allocation. And so you should have more money in your retirement accounts and you just end up having to follow the SEP rule earlier than you thought you would. Then, of course, if taking that risk pays off, then it's that much longer before you have to use the SEP rule to get money out of your retirement accounts. So really not that big of a deal. I would still look at it all as one asset allocation. Our quote of the day today comes from Tim Ferriss who said retirement as a goal or a final redemption is flawed, but because it is predicated on the assumption that you dislike what you are doing during the most physically capable years of your life, this is a non starter. Nothing can justify that sacrifice. So there's a little bit of a counterpoint to the early retirement crowd. I think the best possible thing you can do is find something you really love to do and would do for free anyway that also pays you. But for those who can't seem to find that, well, early retirement is an option if you're a good saver and a reasonably skilled investor. Our next question comes from Mike I've been a reader for a couple of years now, having started my first job as a private practice anesthesiologist in 2015. I'm writing with a quick question I have after having read the multiple 401k rules post. I'm part of a self owned 35 member anesthesia group. All of our income is reported as W2 income and we have a self matched 401 which allows us to defer $53,000 per year. Additionally, I've recently begun doing some consulting work for pharma in a local hospital which is paid on a 1099. I'm wondering if there is a means by which I can open a self employed 401k for the latter and in doing so invest more income in a tax deferred manner. Specifically, do I need to create some sort of business construct like a sole proprietorship or an LLC to enable this extra tax deferred savings? Well, the good news is that Mike sounds like he does qualify to have multiple 401 s. So if you have two completely unrelated employers, in this case the hospital and himself, you can have two 401ks. And although you only get one $18,000 per year employee contribution, you can make employer contributions if you have enough income up to the maximum of $54,000 per year in 2017 if you're under 50. That's exactly what we do here at the White Coat Investor. I not only have a 401k profit sharing plan through my partnership, but we have an individual 401k for myself and my wife to which we contribute another $54,000 per year. You don't need any special business construct to do that. I mean, if you receive Money on a 1099 you are by definition a sole proprietor. You don't have to actually do anything to be a sole proprietor, you just need to get an employer identification number, which is totally free and takes five minutes online from the IRS website. It's just an ein and that's all you need to open a solo or an individual 401k as a sole proprietor. Bear in mind that going for more complex business forms such as an LLC or an S Corp is certainly not required, although at times there can be some tax advantages to doing so. For the most part, you can take all the same business deductions just being a sole proprietor and you don't get any additional malpractice liability protection from that business structure. So in general, if you're just doing a little bit of moonlighting on the side as a doc, a sole proprietorship is just fine. Next question is from a Resident. Hello, I'm a third year psychiatry resident. I started med school much later than most and will be in my mid-40s when I complete residency next year. I have $200,000 in student loans. I don't mind working into my early 70s and due to my specialty, this may be more possible than for others. How would your strategies differ for someone in my position? Well, it's really just the same game. You're just starting a little bit later, so there's maybe a little bit more urgency, maybe a little less room for mistakes. But in reality, nobody is really ever more than about 10 years from retirement with a physician income and a very frugal lifestyle. And even if you're not practicing until you're into your mid-40s, you've still got 20 to 30 years. So if you only need 10, you got 20 or 30. It's not the end of the world. In fact, there's a lot of things that benefit you if you're older. When you start saving for retirement. For example, once you hit age 50, you can start putting more into 401ks and IRAs than you could prior to age 50. At 55, you're allowed to put more into your HSA. And so there's lots of benefits there in addition to, you know, not having to worry about things like the age 59 and a half rule, because you'll almost surely be working that long. In addition, if you can work until 70, well, that's going to probably mean more Social Security for you. So those are all good things that work out just fine even with a late start. The key, of course, is getting rid of that student debt relatively early. So your income, your greatest wealth building tool as a physician, can be going toward investments and building wealth to pay for your retirement here's another question I got I'm 41 and am currently on track to be financially independent in my early 50s. That's quite a difference from the last writer, isn't it? One challenge I have in calculating a retirement number is the fact that Social Security won't be kicking in for the first 10 to 20 years of retirement. Is the best approach to determine the present value of expected benefits and add this to my net worth. Should I just ignore it and consider it a bonus if it happens? Other Ideas well, here's the way I look at it. If you're retiring in your early 50s, you're going to need to make do without Social Security for 17 to 20 years, most likely, and mathematically that's almost exactly the same as just ignoring it completely in your calculations. So I think what I would do is probably just plan to delay Social Security to age 70, at which point it provides a little bit of longevity insurance for you. That of course, if you're married, only applies to the higher earner and the couple. A lot of times it makes sense for the lower earner to claim earlier, but I just ignore it until that point. You know, when you're a very early retiree, I think it's reasonable to ignore Social Security because you have to go so many years without it. But if you're retiring relatively close to the age at which you'll start getting Social Security, I think you probably ought to be counting on it quite a bit more. But that just depends on how far away you are from receiving it. All right, here's another question from the forum. If you haven't visited the White Coat Investor Forum, I highly recommend you sign up. It's totally free and there's a lot of smart people on there that can answer many more questions than I can do myself. But this Poster writes I'm 33 and will be starting fellowship this upcoming July and we'll be making about $75,000 for the year. I have roughly $41,000 in a 401k from my soon to be prior employer and I need to figure out what to do with it. My base living costs, including insurance, a car payment on a Toyota Rave 4, two kids, preschool tuition, Internet and cable is about $4,500 per month. I'm thinking about cashing out the 401K and using it for living expenses during fellowship, but I'm not sure if this is the wisest idea as many people have advised against it. My reserve about not cashing it out is that cash flow is going to be an issue next year. I would prefer not to rack up credit card debt. The other kicker is my student loans will come due starting halfway through the year. I would have to do income based repayment and it looks like an additional $400 to $500 a month. I'm in a high paying specialty, so when I finish, I should be able to recontribute quite a bit to retirement every year. Well, objectively looking at this and realizing I believe this doc turned out to be a neurosurgeon. You know, this doc's going to make a very high income throughout his career. There's no doubt that he can make up for taking out, you know, 15, $20,000 or even the whole $41,000 out of the 401k. He's going to be able to make it up later if he has enough discipline to be smart about, you know, using his neurosurgery income to build wealth. But I don't like the habit that's being formed. I mean, here's a doc with spouse and two kids who's having trouble living on $75,000 per year. Now the average American household makes about $50,000 per year. So he's making 50% more than the average American household having trouble making ends meet. Well, that's how all your patients are going to be throughout your career. I think it's a very good idea to learn how to live on it, at least for a couple of years in your life, just to see what it's like for your patients. But I think the habit of learning to live within your income and even saving on a resident or a fellow income is really important. And I think it carries through to those first few years of attending hood. I mean, how tough is it going to be to live like a resident as an attending if you can't live like a resident while you're a resident? So I think if I was looking at this sort of situation, I was looking at preschool tuition for the kids and I had a cable and I had a car payment, you know, maybe I'd be looking at really trimming my lifestyle back a little bit and trying to at least live within my means on $75,000 a year rather than looking for additional income. I get a related question from time to time of people looking for a loan they can use for living expenses during residency or fellowship. And I feel about the same way about it. This doc's a little bit better ahead than a doc just looking for a loan since he's actually using his own money that he saved in the past. But that money is aimed for retirement. When you put it in a 401k, there is a penalty to pull it out for something like this unless you can think of some of the, you know, exceptions to get to it without paying the penalty. And so I think it's really probably not worth it at this point. I'd be trying to, you know, do Roth conversions on as much of that money as I could afford to before getting out of fellowship and when my tax bracket goes up rather than trying to figure out how to spend how to get more money to spend on my lifestyle. But, you know, the truth of the matter is, as a neurosurgeon, that money's coming later. And if you can be disciplined with your attending income that first year or two, it can dwarf any minor mistakes such as this one that you make as a resident or a fellow.

If you're looking to boost returns, lower taxes and build wealth, join the WCI Monthly Real Estate Opportunities List for tips and strategies to maximize your real estate returns. And for introductions to exclusive investment opportunities, expect educational emails that introduce you to syndicators, fund companies, online courses, and online real estate platforms. Go to whitecoatinvestor.com reopportunities to sign up today. You can do this, and the white coat investor can help.

Head up, shoulders back. You've got this stuff. Money's not that complicated. You can figure it out and you can be financially successful as a physician. See you next time.