June 9, 2016
So everyone ‘knows’ that they should never withdraw from their retirement accounts until 59 1/2 years old, right? Most people cite the 10% penalty that you’d have to pay to the IRS as the big prohibitive cost…but what if the math suggests otherwise??
I heard about the possibility that you may actually come out better off by investing in a tax deferred retirement account, even if you plan on using those funds to retire early. Assuming the same investment returns and timeframe in the comparison of taxable, tax deferred, and tax exempt accounts, you will almost always have more total money to spend if you withdraw the earnings on your original capital during the pre-59.5 years (paying the 10% penalty) and leaving the original contribution to continue to grow until after 59.5 years old. The only time a taxable investment appears to be better is if you can keep the effective tax rate under 15%, which is not too easy because it likely will limit the available investments that are tax efficient enough, further making the case in favor of tax deferred accounts. Pretty incredible if you ask me!
This topic has been described in great detail by Joshua Sheats of the Radical Personal Finance podcast (who I believe got the idea from Bryan Rosner of the Smart Money Better Life blog), so definitely check them out for more detailed information. Joshua Sheats describes it well and provides links to his math proofs within his podcast show notes.