Are you financially prepared for life after retirement? This episode of the One for the Money podcast is all about generating income in early retirement. Congress has put a 10% penalty for those who access IRAs before age 59 and a half, but I’ll be going over ways you can generate income. Listen through to the end, and I’ll share some early retirement tips, tricks, and strategies, including an easy math trick that allows you quickly to understand interest, rates of return, and how they impact both your investments and debts.
In this episode...
- The tricky first years of retirement [01:33]
- Retirement income sources [02:30]
- Workarounds to access retirement funds [04:41]
- The Rule of 72 [08:53]
Accessing retirement funds
The first few years of retirement can be the trickiest to generate income because Congress has applied a 10% penalty for Americans who access their retirement funds before age 59 and a half. The purpose of the penalty was to encourage Americans to keep their monies invested for longer to benefit from compounded interest. Consequently, it requires some deft planning to generate income during the first years of early retirement.
Income sources in early retirement
The simplest income source is savings, the money you have in the bank. Savings is money in addition to an emergency fund and should be the first money spent in early retirement because it just sits in the bank. I recommend that early retirees begin saving extra money in the bank in the few years just before early retirement. These savings will be the money you want to spend first, so it won’t be subject to risk in the stock market, where a downturn can reduce what you already have. Another income option is a non-retirement account, which is a great way to save more if you’ve already maxed out your retirement accounts.
Roth IRA contributions are made with after-tax money. Because you have already paid taxes on this money, the IRS allows you to withdraw the contributed amounts, not the gains, at any time without taxes or penalties. For example, let’s say you contribute $5,000 to a Roth IRA in 2015, and it grows to $10,000. In 2020, you can take the $5,000 contribution out with no taxable consequences. However, the disadvantage is that less of your money will be compounding. So I wouldn’t recommend that you utilize the Roth IRA for funds in early retirement because you want this tax-free money to continue to grow as long as possible.
Understanding interest
One of the most important things people can understand about finances is interest. Fortunately, a simple math trick called the Rule of 72 can help us understand how interest can impact our finances from both an investment and debt perspective. The Rule of 72 is a simple way to determine how long an investment will take to double, given a fixed annual rate of interest. All you need to do is divide the number 72 by the annual rate of return, and you will obtain a rough estimate of how many years it will take for your initial investment to double. The Rule of 72 is a powerful means for anyone to understand interest, which is integral to understanding finances.
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