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You can have it all, too. Visit cmhserviceindustry.com to learn more. I've gotten a lot of questions with all of the early retirement interviews I've played on this show about how all these people are going to access the money that they have stuffed away in retirement accounts if they retire before the age of 59 and a half.

After all, aren't they going to have to pay the penalty tax to get their money out? Today, I'm going to answer that question and give this show a shot. Whether you're a beginner or an expert on this subject, I think I might have some ideas that will help you.

Welcome to the Radical Personal Finance Podcast. My name is Joshua Sheets. Thank you for being here. Today is Monday, November 17, 2014. Today I'm going to tell you why you might not pay the penalty taxes even if you retire before 59 and a half. Then I'm going to tell you how to avoid them all if you want to.

I'll give you all the answers for that. Today's going to save you some money, so stay tuned. As we wade into the weeds of retirement rules and laws and things like that, I'm going to ask you to do me a favor. Give today a shot. I'm going to try to do this with a minimum of detail, meaning I'm not going to get down to the technical weeds.

I'm going to try to answer this big picture with just enough detail and then let me know how I did. I'm pretty excited about it. I feel like I can do it. Two quick announcements as we start. Number one, as I've been saying for the last week, I wound up deleting all of you who are subscribed to my show in iTunes.

It was accidental. Trust me. That's not something that a podcaster wants to do is delete the majority of their audience when you work so hard to build an audience. If you are subscribed to my show in iTunes or even if you're subscribed in many other podcast apps, many podcast apps actually use iTunes and scrape from iTunes the info, then please make sure that you are receiving updates on the show in your app after episode 99.

This is when it would have happened. If you are receiving today, which is episode what? 103, I think, or 104, something like that. Then 104. Then if you're receiving after today, then that's great. If not, unsubscribe from the show, look in the store or the directory for the show, and then click subscribe.

If you're not subscribed to the show, why not? Subscribe. Number two, for you international listeners, I apologize. Today's going to be fairly US-centric. I think there'll be some info in here that you'll benefit from. About 80% of the audience is based in the US and 20% is international. The top three, 5% in Canada, 5% in the UK, and 5% in Germany, and then the remaining 5% scattered around the world.

I thank all of you for listening. I never in my life imagined I would be speaking to an international audience. Several of you, especially the Canadians, have emailed me and asked me to do shows on Canadian personal finance topics. I would love to do that. I think it'd be really fun to do.

I don't know a thing about your laws, so I'm going to have to do that in terms of an interview format. If you've got somebody that you think would be a great guest on the show to talk about financial planning from a Canadian perspective, especially if they might know things that are similar, dissimilar, I'd love to learn about it.

I can do that in an interview format. If you've got somebody, ask them to email me or you email me for them, joshua@radicalpersonalfinance.com. Let's get into the show. We're not going into the weeds today. I'm going to stay with some big picture concepts, but I'm going to give you enough detail that this is actually going to be useful.

I've gotten this question several times, and although I have covered it briefly on a previous show, I think in the show where the guy wrote me and says, "I'm 35 years old. I got a million bucks. I hate my job and I don't want to retire," at the end of that show, I put some of this info in.

The number one response I got on that show, I think it was episode 55, it might have been, was, "Joshua, you crammed like eight shows into one. That seems to be my disease." So I wanted to create a standalone show to answer this question, and that's what we have today.

I used to be very scared by this question or by this problem, and you probably have been or are right now. You know what? Maybe you should be because when you get into the world of figuring out what are the penalty taxes and things like that, it just doesn't sound fun, dealing with penalty taxes.

None of us really want to deal with penalties and none of us really want to pay taxes. One of the big problems in this area is actually the problem of perspective. Who are we talking about? So you've heard where this question comes from is if you've listened to my show and you've heard various early retirees, people planning on retiring at 30, 40, 50 years old, and you're saying, "But they have all this money in 401(k)s.

What do they do?" And if you go and listen to mainstream personal finance topics, you find that the standard advice is don't ever take money out of your retirement accounts early. You have to wait until 59 and a half. Why would you ever take money early? This is especially tough when you listen to radio shows.

So for example, two of my favorites, if you listen to Clark Howard or Dave Ramsey, if they get a listener, unless they do a lot of probing and find something out, the majority of the time when people call them up and say, "Hey Clark or Dave, I need to distribute money from my 401(k), should I take money out of my 401(k) to pay off my credit card debt?" Well, the most common answer you'll hear is no, absolutely not.

And here's why. Here's the math you'll hear. No Mr. Collar, if you're Ms. Collar, because you're going to pay a 10% penalty tax plus you're going to pay taxes on the money. So let's say you're going to pay 30% taxes. So you've got 30 plus 10, that's 40%. Practically half your money, you're going to lose half your money to taxes and penalties, so therefore you shouldn't do it.

Now is that true? Well, it might be. I don't know. I mean going from 40 to 50 is kind of a big deal where we just automatically say half and I'll tell you I have been guilty of that working with a client who's called me in the same situation.

I'm like, "Well, you basically lose half your money. It's half your money." I've done that myself. I've done that myself. So maybe I need to atone for that with today's show. But there's a big difference between that type of caller and that type of situation versus somebody who is financially sophisticated and understands the rules and has a plan for early retirement.

They have a lot of money. They're saving money. They're using their retirement accounts as a tool. And this is a big difference. And this is one of the reasons it's tough. If you're used to listening to mainstream financial talk, nothing wrong with that. That's great. But you've got to recognize that you probably have a different perspective than maybe what I talk about on this show.

There's a big difference between saying, "I've got to take my money out to pay off my credit card debt," when the majority of people that I'm bringing on this show, at least to talk about early retirement, credit card debt is nowhere near an issue. It's just not even in the same ballpark.

That's why it's kind of tough for me to answer questions on credit card debt because I just don't think that much about it. If you have credit card debt and if you're paying interest on it and it's not deductible interest, I'm just like, "What are you doing? Why would you do that?" So there's a little bit of a different approach to my show versus the other.

So you've got to ask yourself the question, "How sophisticated are you when you're actually doing this problem? Do you need help on the fundamentals of finance, the fundamentals of getting out of debt, working hard, planning a budget, doing that? Or are you ready to go a little bit deeper?" If you're sophisticated and if you're deeper, that's where this conversation is going to go.

If you're dealing with the question of, "Should I take money out of my 401(k) to pay off my credit card debt?" The answer is probably not. Probably not. It's usually not going to be a good plan. But you still could calculate it, but that's not the realm that we're talking about today.

If you take all of the emotion out of this answer and you take all of the rules that you've heard about, "Don't only take money out of your 401(k) if you're going to declare bankruptcy or escape foreclosure," that's probably a good rule of thumb. I like rules of thumb.

But it's one thing to have the rule of thumb. It's another thing to go beyond the rule of thumb and understand it. If we actually understand it, we basically have two questions that we're trying to figure out. Number one is, "What is the cost versus the benefit of paying income taxes now versus paying them later?" Number two, "What is the cost versus the benefit of paying the extra 10% penalty tax now or not paying it later?" That's it.

So why did I start with all those tax planning shows in the beginning? Go back and check out the tax series. It's all there in your feed, freely available. All we're doing here is adjusting the timing of income. That's all this is, is a timing strategy. And you're just saying, "Do I take the timing of income forward or do I push the timing of income back?

Do I take this deduction now or do I push the deduction back?" So let's handle the income taxes first. You are always going to pay income taxes on the money if you're using a retirement account. You're always going to do it, period. You're either going to do it now because you're participating in a Roth IRA or a Roth 401(k) and so you're choosing to pay the income tax now and to avoid it later, or you're going to pay it later.

If you're participating in a traditional 401(k), a traditional IRA, a simplified employee pension plan, a SEP, a simple IRA, you're just taking the deduction now. So all we're doing is we're choosing, "Am I going to pay now or later? Now or later? Do I push the tax off, pay it later?

Do I bring the tax forward and pay it now?" And the answer to that question is pure math. What's in your best interest? Well, you have to actually calculate it. You have to look at your situation. You have to look at your plans. Now with regard to the penalty tax, it's still just a timing question.

Do I pay the penalty tax in order to have the money now or do I not pay the penalty tax later? Now you would think that would be straightforward, right? But it's not. Well, in some ways it is, but it's not. Here would be an example. If I tell you that in your 401(k) you're going to average 10% on your money and you're going to take that 10% on the money and you're going to keep it invested, thus avoiding the 10% penalty tax now, you're going to get a 10% rate of return annually over the next 30 years.

Or you can go ahead and take the money that you have in there now, pay the 10% penalty tax and invest the money at 110% rate of return compounded annually for the next 30 years. Which would you do? Obviously if I could guarantee it, and of course I can't, but it's just a mental game, obviously you would take the 110% rate of return because you would make up far in excess of the cost of the 10% tax.

So therefore all we're doing here is trying to figure out should I pay the 10% penalty tax or should I not pay the 10% penalty tax? And there are various ways to answer it. Do I value the money now or do I value not paying the tax? It's not a law, it's not a rule, it's not a religion, it's just a matter of when do I value it?

What's my plan for it? If you're going to take the money out and that money is just going to go to pay off credit card debt and you're taking money out and you're paying half the money in taxes and penalties and fees so that you can pay off credit card debt at a 10% interest or 15% interest, probably not a good plan.

But if you're taking it out to invest in your business that is guaranteed to be the next big IPO success, maybe it is a good plan. There have been plenty of entrepreneurs who have taken early distributions out of their accounts and made way more than they ever would have had by having the money in their accounts.

There are many, many businesses that have been started and funded based upon pensions. There are many businesses, whether that was Colonel Sanders just living on Social Security while he starts Kentucky Fried Chicken or whether it was JCPenney, either starting JCPenney or rescuing JCPenney with money from his cash value life insurance policy or people taking distributions from their 401(k)s to start their dream.

That's fine. I've got lots of friends that have done that. So get the emotion out of it and understand what the rules are and then you can coach yourself or somebody else through it. And it's basically what do I expect to do better? That's it. Now all tax planning is very specific.

You have to look at your situation. And I'm going to say things in today's show that are going to be absolutely contradictory to one another. All you've got to do is just avoid, avoid, avoid, and that's your key. Now the question is what are you avoiding? Sometimes we'll choose to pay some taxes in order to avoid paying another one.

So we can avoid the 10% penalty tax, but we might choose to pay it to avoid paying a higher income tax. That's basically it. Same thing with we can avoid the AMT, the alternative minimum tax, by paying a higher amount of income tax because we choose that the higher income tax is a better deal than the AMT.

Same thing with we're doing tax planning for this new Medicare tax. We're just simply avoiding. So you've got to look at your situation. And what you need to do is just calculate it out, figure out what the cost is, figure out what the benefit is, figure out what the plan is, and make that decision.

The key with the early retiree scenarios is that they have flexibility. And that's what's often missing in mainstream financial advice is there's no flexibility. If you're stretched to the max with income equaling expenses and no money to pay off credit cards, there's no flexibility. You can't take advantage of strategies like we're going to talk about here that the early retirees have grabbed onto.

So you've got to have flexibility. Now there are real quick answer, and we're going to get to the four different options that I'm going to explain to you today. But there are a bunch of detailed rules and exceptions for each type of account. I do not want to cover those in today's show because I want to do shows at some point on about a specific topic.

So the early distribution rules are different for IRAs than they are for 401(k)s. And they're different for IRAs than they are for Roth IRAs with the exceptions. So the death exception, the disability, the first-time home purchase, the medical expenses, the medical insurance premiums during unemployment, the higher education costs.

Some of these exceptions that you can find to paying the 10% penalty, they exist, but I don't want to cover them today because it just gets us too down in the weeds. And you've got to figure out, depending on whether you have a Roth or a traditional IRA, that makes a difference.

And with a Roth, you've got to figure out are we avoiding the 10% penalty tax or are we also avoiding the income tax on the money. With 401(k)s, you've got double counting of rules. So if you've got the Roth rules with a Roth 401(k), you've got your five-year rules that apply because of the Roth portion, but you've got the challenge of how do I get my in-service distribution out of a 401(k).

You could take a loan, but the loan has its own issues. Does your plan offer loans? So there's all kinds of issues with it. So I'm not getting into those weeds. I want to give you four answers, though, to help you organize your thinking, at least to understand why and how all these early retirees I brought on the show are avoiding the tax or how they're making rational decisions.

There are four answers to this question, how are they doing it. And I'm going to give you the four and then we're going to go through them in detail. Answer number one, they might not need to actually pay the penalty taxes because they might not need to actually make the distribution from the account.

Even though all the money or most of the money is in a tax-qualified account, they might not actually need to pay the taxes because they might not actually take the distribution even though they retired before 59.5. And I'm going to give you some various scenarios to that. Answer number two, they might just pay the penalty tax.

It might be cheaper to pay the penalty tax than to pay some other tax or other expense or other fee than the penalty tax. And then we're just getting into what's the calculation. Then number three and four are the well-known options to avoid the 10% penalty. Option three is the Roth conversion option.

And then option four is the series of substantially equal periodic payments, also known as the 72(t) rules. So I'm going to cover three and four, which are the technical ones. So let's start with number one. How is it that somebody comes on my show and they have all their money in their 401(k) and they say, "But I'm going to retire at 35 years old." What?

Well, here are a few ideas for you. There could be many reasons why they may or may not actually take money out of the accounts that are going to be penalized. And quick other caveat, I'm primarily today talking about avoiding the penalty, not so much talking about the income tax.

I'm primarily talking about the penalty tax, but the income tax will weave in. So the first example that comes to mind for me is that most retirees, or at least early retirees that say they're going to stop and stop spending money, don't—excuse me, stop making money and thus start spending savings that they have, don't actually ever stop making money.

Or if they do, it's temporary. The most recent example I would point to here is my friend Brandon, the mad scientist. I've had him on the show. He's back in the first 10 episodes. He's going to give a great interview. Brandon is a young guy. He and his wife have been working on this early retirement plan.

They're retiring in their early 30s, and he's been working on it for a few years. So his plan, he's hardcore. I'm going to mention his site later as a great resource for you with really accessible articles on this. But he's hardcore with retirement accounts. Put everything in an IRA, put everything in a 401(k), defer everything, cut all your taxes across the board, and then pursue a Roth conversion strategy.

So he's super detailed with it. He's awesome at it. So he goes in. He's working his plan, and I'll link to the article where he talks about this in his show—excuse me, in the show notes for today. But he's working his plan, and he's planning to quit. He was working at a university, so he could get a free master's degree there at the university, saving tons of money, not spending anything.

And he and his wife are planning to move to Scotland. And so he goes in and he quits his job, per the plan. He's financially independent. He's hit his date. He's gotten all the money. He goes in and quits his job. And a few days later, his employer gets in touch with him and says, "Brandon, no, listen, you were great.

You were really useful to us as an employee. Would you be willing to keep on working for us, doing what you're doing from wherever in the world you want to do it? And in fact, we'll give you a 20% pay raise over and above what you were making." Huh.

So it seems like at least for now he's accepted it. Now, will he do that for the rest of his life? I don't know, and he doesn't know either, I'm sure, unless—maybe it's six months, maybe it's six years. He's not at all. But the point is that this happens a lot of times.

And so people end up making more money after they declare themselves financially independent, early retired. Now, some people don't, theoretically. I haven't been able to find any of them or at least get them on the show. We're having a thread in the Money Mustache forums where people are like, "Get someone who's lazy on the show." I'm like, "I can't find anybody who's lazy, who's willing to make the effort of coming on my show." But the point is, Brandon—so he's making 20% more, and even though he's got all this strategy of how do I get the money out, he's still making more money.

So he doesn't actually need the money. So he declared himself financially independent, and yet he's still working. Now, does this violate the whole idea? No, of course not. It doesn't. Because probably the biggest benefit to declaring yourself financially independent is psychological. It changes your options. You can do or not do anything you want, which is why even though I'm not in favor personally for me of never working again, I can't conceive of that being a desirable thing or a good thing or even something that I would ever even consider.

Yet it's one thing for me to say that from where I sit right now, not financially independent in my definition, versus if I were financially independent in my definition of it. So you might still work and earn some money. I haven't actually—I've hardly ever found anybody in the early retirement space who hasn't continued working and doing something else, whether that's the ones that are well-known today, you know, Money Mustache.

He's making more money now than he ever did in his life. I guarantee it. His blog is doing great. He's got all his construction projects. He could make more if he wanted to. He's not that into it. So the point was it's hugely valuable to be financially independent, but it doesn't mean you actually have to do it.

Jacob Fisker, same thing. He's working, making money. I've reached out to other older authors, actually, of other traditional books, and I have found that many of them, after they wrote their books some number of years later, they just went on and went back to work. Now, does that mean everyone—no, of course not.

Not everyone does that. I think Joe Dominguez, who wrote Your Money or Your Life, to the best of my knowledge, he spent the rest of his life volunteering, and he donated every dollar he made for the rest of his life. Doug Nordman from the financial—what's the military site? Military Finance or something like that, whatever his site is called, he donates all of his money that he gets from his book and from his blogging to military charities, and he just lives off of his retirement savings.

So that's great. But the point is, he could. Now, another reason why you might not have the money coming out from a retirement account early even though you're declaring yourself financially independent is perhaps your spouse is working. So the other example, to the best of my knowledge, Brandon is from Mad Scientist.

The plan is for he and his wife to move to Scotland, and I think that she is planning to continue working. She's Scottish, and she's either an ophthalmologist or an optometrist doing something with eyes, and so the plan is for her to continue working. And so very well, they could live on that income for a family and just keep the money in retirement accounts.

Same thing, Jacob Lundfisker, when he was writing Early Retirement Extreme, his wife was still working and earning money. Now, how they handle that on tax planning doesn't matter to me, whether they handle their finances separately, whatever. I don't understand why people in a marriage ever handle their finances separately, but live your life, do what you want.

I think it doesn't work for me, and I wouldn't do it, and I don't think – anyway, you'd have to convince me. I've never found the argument that's convinced me, but if you want to do it, fine. But so for me, if I chose and declared myself financially independent, if my spouse were working or vice versa, then we're financially independent because we have the money in the retirement accounts.

It doesn't mean we actually pull it out, and that's fine. You might do something like – another option, you might wind up getting an inheritance. Maybe your parents die and leave you money. Maybe your Uncle Joe dies and leaves you money. It happens, and there's no reason then in that situation not to spend it and keep the money in the retirement accounts.

You might do something like using other assets. So you might have something like a house, and you might sell the house. And so for many people, maybe all of their assets are in a house and a 401(k). That doesn't mean they can't retire early. It just means they'll probably be selling the house and spending those proceeds or selling the house and buying a rental house instead and living on that money.

You might have other accounts, or the early retirees might have other accounts that are deferred but that have less restrictive rules about 59.5 than an IRA or a 401(k). So the examples that quickly come to mind are deferred comp programs including a 457 plan. When I was at Northwestern Mutual, I had several retirement accounts and various accounts available to me.

I had two different pensions that I was eligible to based upon different calculations and formulas, and I also had two different deferred compensation programs that were available to me. I had a short-term deferred compensation program and a long-term deferred compensation program. And basically, it's super simple. I could just tell Northwestern, "Defer this amount of my income based upon this formula into this specific year." So I always plan to use this in my life as part of my—basically to fund my plan of taking sabbaticals or distributed retirement throughout my life.

I've had the idea of how I would prefer to work, to work in chunks. So each year, I've been working towards—I haven't hit this every year, but for the last five years, I've been working to try to work in essentially three-month chunks of time. So my plan was always to work January, February, March, take April off, work May, June, July, take August off, work September, October, November, and then take December off.

And I like that from the perspective of it gives me the time to tackle major projects, and I would wind up working 75% of the time. And based upon how I like to work, I think that I would actually get more done in that really focused time and then having the time off on the—of every fourth month.

And I could distribute that into projects. It would work well with my family. We could take month-long trips, which to me is an ideal length of time. It's long enough to feel like I don't have to fit into this silly six-day vacation weird thing that we US Americans do.

But it's also not quite as big of a deal as setting your life up so that you can leave for six months. So that's how I've—even I've approached it for the last few years. I haven't hit it every year as organized as I would like, but I've always been able to take at least a month off, often closer to two, depending on how I structured it, every year for the last basically five years.

And I work harder during the time that I'm here than take my time off. I also have had the plan of doing sabbaticals. I never wanted to do this when it was just me. And at this stage with a young son, I don't want to do this. But as my son and hopefully—we're hoping to have more kids, then hopefully more kids get a little bit older, then I plan to take sabbaticals.

I want to take a year off or maybe two years off or a year and a half off. So I could use something like my deferred compensation programs—and this was actually my plan—was to basically just defer 20% of my earnings into this account. And then every fifth year I'd have one year of income sitting there waiting for me.

Now from a tax perspective, this was purely a deferred compensation program with no age 59 and a half restrictions. And so I could keep the money there, and every fifth year I would have the same amount of income that I had in years one through four. So this was my plan of to use that specific plan to cover myself.

So these programs do still exist. They're uncommon with small employers, which is why most people don't even think about this. We just think 401(k), 401(k), but they're very doable. Usually it's going to be with either a larger employer or it's going to be an executive benefit. So if you're an executive at a large firm, you're going to have access to something like this or at least it's going to be something that you're going to be talked about.

This is an area of financial planning that is pretty niche. Most people aren't familiar with it, but you can set these types of deferred comp plans up. Or the most common one would be a 457, which is a deferred compensation plan for government employees and also for nonprofit employees, essentially.

There's differences between the governmental ones and the non-governmental ones. But basically it just allows you to defer some income into this plan and you could take it out, but there's no, without the age 59 and a half restriction. I'm dramatically simplifying, but that's basically how it works. So if somebody has a 457 plan, if you're a teacher and you have access to a 457 plan, or if you're a police officer and you have access to a 457 plan, you can use this to defer the tax now and pay it in the future without dealing with the age 59 and a half scenario.

You might just have something like a taxable account, a cash savings account, or you might do something like your, maybe, a scenario that I can think of where you would even, you declare yourself financially independent even with a bunch of money in retirement accounts would be, because you can tap the equity on your house and use that to fund your lifestyle.

And many people can do this. And the key is that usually with early retirees, most of the people who are planning this early retiree path, their expenses are so low compared to their assets that it's relatively simple to find some money from somewhere else. So you could combine these plans.

So you could, for example, you turn 50 years old and you're trying to get yourself from 50 to 60 and you have a big house, fancy house, well paid for. You don't need that much money, but you want to stay in the house for five years. Well, you take the equity out with a home equity loan for the first five years.

Then at 55, you sell the house and you spend down some of the proceeds from that from 55 to 60 and then you start tapping retirement accounts. Depends on your scenario. You might have something like a life insurance policy. With Northwestern Mutual, Northwestern, we did a lot of cash value life insurance.

And so that was always something that oftentimes I would come across a client who has this really awesome, mature, well-funded life insurance policy. So a lot of times when you're doing retirement planning, that's a pool of money that we can pool from. And if their dad bought it for them and this thing is crazy mature and we've got all these dividends that we could take out tax-free up to the basis, or maybe we could take out a loan against it to fund as a funding mechanism to bridge from one account to another.

Just depends on the makeup of the person. So that would be one example. They might not need to pay the penalty tax because they don't actually have to take the distributions because there's other money. They might be moving to a different country and earning money in a different country.

So you still have the US taxes, but now you're working in Spain or working in Australia, having fun, making a living. So the money just sits in the retirement account in the US and what gave you the guts to do it was the fact that you didn't need the money, you didn't need to pull the money out.

Some people might work on the black market. Whether that means going around and picking up scrap metal because you think that's fun or whether that means making birdhouses in your garage and selling that for a couple thousand bucks a month or coding on the internet and just making your money in Bitcoin or something like that.

Some people might, because they're financially independent, might just work on the black market and evade the taxes. Some people might, for example, barter for housing. So let's say that I like agriculture. Well, I could easily have a bunch of money in retirement accounts and I want to go out and do slow travel around the world, but I just choose to work on wolfing farms, worldwide opportunities on organic farms, and I choose to work for my living where I lower my lifestyle, my cost for my lifestyle, so I don't need to take money out of the retirement account.

You could keep the house and rent your own house out while you slow travel. And for some people, you have a nice fancy house in a desirable place, you can rent that thing out for two, three thousand bucks a month and that's more than some people will spend traveling the world.

Or two, three thousand bucks for that plus a severance package or something like that. That's a lot of money for some people. And then you might just start a new business that you love with the freedom that you have. So again, prove to me that you can show me an early retiree that completely quits.

Now I found a few of them online. I just haven't been able to get anybody to come on the show because the ones who are actually lazy are too lazy to come on my show, which is fine. Good for them. That's awesome. So in many cases, financial independence or early retirement might just be the mental freedom knowing that I don't have to work if I don't want to and that can be worth it.

It really can be. So that's answer one is maybe they're just not actually taking a distribution. Now that's not probably why you tuned into the show, but I do want to start there because that is what happens. That's actually what happens. Now option two is you might just choose to take the distribution from the retirement account and pay the penalty tax because it's cheaper than something else.

Oftentimes with tax planning, what we wind up doing is paying one tax in order to avoid another more expensive tax. The example that would come to mind off the bat is probably the simplest example would be the penalty tax if you don't take your required minimum distributions off of a 401(k) or off of a qualified retirement account.

So you reach age 70 and a half and you have money in a 401(k), the IRS requires you to take required minimum distributions from that account. There's a formula that it's based upon, but there are many people who reach that point in time and they say, "I don't need this money.

I want to keep the money in the account because if I take it out, I'm going to have to pay the income tax on it." The problem is that if you don't take your required minimum distributions, then you are taxed at 50% of what the required minimum distributions would have been.

So you pay a 50% penalty tax. That's a lot of money. There's almost nobody that has a tax rate in excess of 50% on retirement distributions. So basically you choose to take the money out at say perhaps a 20% rate and pay the 20% income tax now so as to avoid the 50% penalty tax on your required minimum distributions.

Now it could be the other way around. You might choose to put the money into a retirement account and then take it out to avoid a 20% income tax and then take it out knowing that you're only going to take it out when you're paying a 10% penalty tax.

And so therefore paying the 10% penalty tax could conceivably be cheaper. And there are various reasons why it could be cheaper. It could be cheaper because it allows you to actually take advantage of something like an employer match or it could be cheaper just because you've changed what your individual tax rates and tax base and tax rates are.

So if you had something, I'll make an example. Let's say that your employer matches you dollar for dollar into a 401(k) up to let's just make it generous $5,000. So if you contribute $5,000 of your money to the 401(k) and if your employer contributes $5,000 of their money to the 401(k), then in that situation you put in five and you get ten.

Now you've avoided the income taxes. You're going to be taxed on that later when you pull it out. But if you take it out, you're going to have to pay the 10% penalty tax. Well let's run the math. So $5,000 plus $5,000 equals $10,000. Now regardless, you're going to have to pay the income tax if we take it out early and we don't avoid that.

So I'm keeping it purely apples to apples. Now assume you're going to pay a 20% income tax either on the $5,000 that you go ahead and take the income or on the $5,000 that you defer into the 401(k) to get the match. So in your head, you know that you're either going to go ahead and get $4,000 to spend now or you're going to get $8,000 to spend later.

So let's say that you go ahead and you put your $5,000 into the account. The employer puts their $5,000 into the account. You're going to pay $2,000 of income tax when you take it out. But you're going to pay a 10% penalty tax on the $10,000. Well that would be a $1,000 penalty tax.

So now the question is would I rather go ahead and take the $4,000 this year in my paycheck and give up the employer match or would I rather go ahead and put that – it was $5,000 and you paid $1,000 of tax now to get $4,000 in the paycheck.

Or would I rather go ahead and put the $5,000 into the 401(k). They put their $5,000 in the 401(k) and assuming I'm vested – going based on a vesting schedule – assuming I'm vested in their contribution, next year I leave and I take all $10,000 out of the 401(k).

I pay $2,000 of income tax and $1,000 of penalty tax which leaves me with $7,000. That's a net gain. So, you might just say, "Well, this is 10%. I got to pay it." So, that could be very rational. Now it could also be rational because you know of something that's going to happen where you're actually going to change your scenario.

So what comes to mind here is let's say that you're going to change states. Maybe you're working in a state where you have very high state income tax or even a local city income tax. So, if you think of something like New York City and New York State, New York State income taxes vary depending on what the brackets are.

But around – let's see. So, I'm looking at tax-rates.org. So around $154,350 of income for a couple, you get into a 6.65% marginal bracket. So ignoring deductions and credits, every dollar you earn that's in excess of $155,000, you're going to pay 6.65% of income tax on that money. Now if you go to the New York City rates, well, let's see.

So New York City rates look like they range from about 3 to 3.5%. So let's say as an example that you have 3 to 3.5%. Let's use 3.5%. That will make it line up well with the 6.5%. So now if you have 3.5 plus 6.5, you have 10% income taxes.

So what's the harm of just putting the money into the 401(k) and then moving to Florida when you quit your job and taking the money out of the 401(k)? You paid 10% up there and you paid 10% down here of taking it out early. Now the trick would have been in that situation you can exploit probably an income bracket.

So let's say you go from $300,000 of household income to living on only needing $3,000 a month because you're doing an early retirement thing and you were saving 90% of your income. Well in that situation it's pretty simple. You're not going to pay that much bracket and you're going to have zero income taxes.

So you go from maybe an effective rate of 40% up there to an effective rate of 10% in Florida because you're just paying the 10% penalty and you're paying 0% state income taxes and 0% in federal income taxes because you lowered your income needs. That might be a good reason just to go ahead and pay it.

Another example would be California. In California, let's see, again, tax-rates.org, excess couples, in excess of $415,000 of income, the marginal bracket is 11.3%. That goes up to 13.3% in excess of a million of income. So you've got an 11% state tax bracket. If you just simply moved from California to Florida and then took all of your money out of the account, that theoretically could save you 11.3%.

Now does this actually work in practicality? No not in that specific way because the brackets, we're talking about a marginal bracket, it's not quite that neat but it's pretty much the concept. Now when you combine this with the income tax bracket from going with a lower number, this is the other one.

So the two big changes, you might change states from a state that charges income taxes to a state that doesn't or you might also change where you are in the bracket, what your marginal bracket is. So if you went from earning $200,000 a year and you're living an early retiree lifestyle and living on $3,000 a month, $36,000 a year, and then you just went and you started taking off the money at $36,000 a year, you're going to be paying a much lower, even though it's coming from retirement accounts, you're going to be paying a much lower income tax bracket at that money even if you were paying the penalty.

Now you actually have to calculate your specific scenario but this can make a big difference. Could you go from a 30% marginal bracket to a 0% marginal bracket? If so then paying 10% instead of 30, paying a 10% penalty instead of the 30% bracket would be worth it. So you have to start with looking at your actual scenario, looking at your actual taxes, your actual rates, the base, the rates in your situation, and then looking at what your options would be and also what your plans would be.

If you're never going to move from New York City to Florida, don't. Don't do that plan. But I can tell you that's one of the big reasons why we have a gazillion New Yorkers down here. And if you're never going to move from California, don't do that plan. That's not going to work.

You're going to need to do something else. But that is one scenario. So you might be in a lower bracket, you might move to another state, and the other thing is the tax might not be a big deal because it's just doing it for a few years. So maybe, and this is often I think also what happens, is that people are going to retire before 59.5 but they just need money for a few years.

So maybe you're retiring at 50. Well, if you have a ton of money in investments, maybe by then your investments are growing by so much that it's far in excess of the 10% you're going to pay to get the money from 50 to 59.5 and then you're going to take the money out.

Big deal. So is that mathematically perfect? No. But we don't have a crystal ball to know exactly what all of your lifetime plans are when we're sitting down at 22 years old and making out plans. So hopefully that's a good intro. Now we're going to get to the two technical things.

And I'm not going to actually spend a long time, but I wanted to make you aware of those. Answer one, meaning answer that they don't actually take the distributions, that's one answer to the question of how do the early retirees do. Answer two is they might just pay the penalty tax.

But most of the people in the early retiree plan are planning on options three or four. Option three is called the Roth conversion and option four is a series of substantially equal periodic payments. 72T is what it is. So let's do the Roth conversion. Here's basically the principle behind it without any technical talk.

When you participate in a Roth IRA, you can always take your contributions to the account out again without any tax implications one way or the other of any kind. So if you this year put $5,000 into a Roth IRA and next year you take $5,000 out, regardless of your age, there are no tax issues whatsoever with that decision, which is why when you're young this can be a really great move to do is that you fund the Roth IRA and you put your $5,000 in there.

And even if you just kept the money in cash, you can use it as an emergency fund. It's no big deal. Now you have to avoid any kind of penalties or fees that would be imposed by an investment company. So let's say that if you were buying loaded mutual funds where you're paying a commission, you wouldn't get that money out.

Or if you are paying where there's some sort of fee involved, you have to avoid that if you're going to do this plan. But you could do that at a bank with probably no fee and just toss the $5,000 in there. So I would always just use the Roth IRA as just a straight account because you can always take the money out.

Now if you contribute $5,000 to the Roth IRA and next year you take out $5,001, well the $5,000 comes to you with no tax implications. But the $1 of gain will be taxed to you and it might be penalized unless you can avoid one of the exceptions. So that's one of the keys.

So essentially what this opens up for people is – and by the way, sorry, here's the other key – is that on that basis, as long as the money that's in a Roth IRA stays there for – excuse me, I'm getting tongue-tied here. So when you put money directly into a Roth IRA, the rules that I just said apply.

However, you can also do this by converting a traditional IRA or a traditional 401(k) to a Roth IRA. So the example would be, let's say I have $100,000 in my traditional 401(k) and I convert that to a Roth IRA. Now in the year that I convert it, I'm going to pay the income tax on the money.

So I convert it and I pay the income tax. Now as long as I leave the money alone for five years and then I only take out the amount that I converted, I can take out that amount that I converted after five years without paying the penalty tax. So this is the plan that most of the people that are in this scenario are working on.

So I have $1 million in 401(k)s and this is called a Roth conversion ladder. So I have $1 million in 401(k)s and assume that I need $10,000 from my portfolio to support my other forms of income so that I can be financially independent. So this year I convert $10,000 from my 401(k) to a Roth IRA.

I bring that income forward, because remember this is just a timing strategy, an income time shifting strategy. I go ahead and pay that tax on the $10,000 now if there is any. Then five years from now I take that $10,000 out of the Roth IRA and I spend it.

Now in the meantime it may have actually grown. So it may have grown from $10,000 to $12,000, which is great. I still just take my $10,000 out and I leave the $2,000 to grow until after 59 and a half. Or I take it out and pay the penalties on the $2,000 if it's not for one of the other exceptions.

So that's it. So that's what many people are doing. Pile up a bunch of money in 401(k)s, cover yourself for five years through other sources of income, and then transition and transfer the money from the traditional 401(k) to a Roth IRA and then start taking it out. It's called a Roth conversion ladder.

And it's great. There's no reason why it can't work. If you're interested in this strategy, I just explained to you everything you need to know as far as the basics of it, how it works so you can understand it. Now there are some tweaks that you can do and some of the tweaks are pretty cool.

So one of the useful things, the two most accessible resources that I would send you to is our Brandon@MadFientist.com and then Jeremy and Winnie@GoCurryCracker.com. The reason they're accessible is they're normal people and they don't write in financial planner speak. I think you need to learn – it would probably be a good idea if you read the financial planner speak but it's hard for people who are not used to financial planner speak to get it.

And Brandon and Jeremy, because they're normal people, they write in normal language. So start there. Now then go from there. Go to the financial planner stuff and make sure you get the rules. But they do everything. They talk about everything that you need to know. They're normal guys. And so start there.

Now the problem with – I mean here's the advantage and disadvantage and here's why many of the early retirees are doing it. In order to retire early, you have to learn to live on a much smaller percentage of your income than most other people. Does that mean you're used to living a good life on not much money?

Now that means you're willing to continue it also on not much money in retirement. And so the crazy thing is our tax code penalizes productivity. So as long as you can suit your lifestyle to not much money, then you can escape the tax code. It's crazy. Excuse me. To me, I understand but I don't understand.

I think it's stupid how our tax code is set up where it completely penalizes any kind of productivity and the more productive you are, the more it penalizes you. So some people just ignore it and press through and a lot of people say, "This is stupid. Why should I do it?" So if you can be a slacker and just simply stop being productive, you can stop paying taxes.

Go read Jeremy's articles on that. I interviewed him on the show as well, previous episode. Go look through the archives and see Jeremy from Go Curry Cracker. He publishes his tax returns online, pays no taxes and lives a slacker lifestyle, which is awesome. Good for him. I just think it's a sheer and utter total waste of talent to have very smart people like Brandon and Jeremy spending their life energy avoiding taxes.

It's even worse to have a whole army of financial planners expending our life energy to help people avoid taxes. I do not get it. It frustrates me. I have a difficult time having political conversations about taxes with people because I understand. Look at the incentives. Look at the facts.

Look at how just stupid all of the laws are as far as when they're put together. Don't you realize that people with money have plenty of money to hire guys like me and guys ten times smarter than me and more well-read than me and gals 20 times smarter than all of us to find the loopholes and exploit them?

If you're making $3 million a year, a 2% savings on your taxes, that's big money. Now, if you're making $30,000 a year, that's not a big money, but 2% savings, that's $60,000 if you're making $3 million a year. So you have this whole stupid tax code. It's all cobbled together with this and that and this and that and this and that.

And you got to, anyway, rant over. But it's just utterly stupid. I hate spending my life energy helping people avoid taxes, and I think it's despicable that we're taking some of the smartest people, incredible guys, and it's like, "Why should I bother to work and pay taxes?" It's just dumb.

So go look at how Brandon and Jeremy are talking about it, and you'll understand the Roth conversion scenario. And there's some good stuff. So the key is here, you have to actually understand how much you're going to spend. And this only works, this strategy only works well. It works okay, but it only works well if you're going to be spending a much lower amount of money than most other people because all the tax breaks in our tax code are for the poor.

So if you can just simply not make much money, then you can be poor and you can not pay any taxes. I'm intentionally not giving you a lot more detail than that because you need to research this for yourself. And so start with Brandon and Jeremy's, and then from there, go to the IRS website is what I would do and start reading their stuff.

If you can deal with IRS-speak or financial planner-speak, that would be a good place to go. My hope is that you'll research it. And I love the early retirement scenario. One of the things that's so frustrating, and the reason why, one of the things that's frustrating about traditional financial advice is if I tell a traditional person sitting in my office, just lower your expenses to $3,000 a month, people look at me like I have two heads.

The standard answer when you're a financial planner, if you ask somebody who's making $6,000 a month how much they want to retire on, they say $10,000 a month. And you say, "Are you kidding me? Do you not get this?" But that's the standard answer. Now in the early retirement space, the cool thing is if you ask somebody making $10,000 a month how much they want to retire on, they say $2,000 a month.

So it's pretty cool. This works really well in the early retirement space. I hope that helps. Read the articles. Pay special attention to the tax rates on dividends and capital gains. You can do fancy stuff. Like Brandon has a great article on what he calls the Roth IRA horse race, which is a cool little technique.

Basically at the beginning of every year, you convert two accounts. You invest one in stocks, one in bonds. Whichever one comes out better at the end of the year, you keep. And the other one, you recharacterize and undo that conversion and then flip it back before the end of the year.

It's a cool strategy. Read that. You can do cool stuff like front-loading your accounts at the beginning of the year and seeing what ends up being better. There's all kinds of stuff, but I don't want to go any deeper than today. So hopefully that helps you to understand the Roth conversion ladder.

Option number four is often referred to as the 72(t) distribution. You'll see it as 72(t) or SEPP, which stands for substantially equal periodic payments or often I'll refer to it as a series of substantially equal periodic payments. So basically this is one of the exceptions to paying the penalty tax.

And so 72(t), section 72(t) of the Internal Revenue Code is where you find all of the exceptions to paying the penalty tax. And one of those exceptions is that the 10% additional penalty tax will not apply to a distribution which is part of a series of substantially equal periodic payments.

Now how is that defined? Well, it has to be defined in this way. Number one, these payments cannot be paid any less frequently than annually. So that's IRS speak for saying it's got to be at least once a year. Number two, those payments must be paid without changing the amount until the longer of five years or until you reach age 59 and a half.

So if I'm 30 and I do this, I cannot change the amount coming from the account until at least 59 and a half. If you do this at 57, you have to go for at least five years. So it has to be paid to you without changing the amount of the payment for at least for the longer of five years or until the payee reaches age 59 and a half.

Next, the distribution has to be based upon the life expectancy of the recipient or the recipient and their beneficiary. So it has to be paid to you based upon your actual life expectancy. And this is the big problem. It has to be based upon a reasonable rate of interest.

And if applicable, it has to be based upon reasonable mortality assumptions. Here's the key. Once you start taking payments, those payments may not be changed. They may not be increased. They may not be decreased. They may not be changed in any way before the age of 59 and a half or the end of five years, whichever of those is longer.

Make sense? If the payments are modified in any way, then the 10% penalty tax is applied retroactively to all payments that are received before 59 and a half. That's a big deal. That's a huge deal. If you change the amount at any age, then the 10% penalty tax has to be paid retroactively.

Now if I do this at age 30, I'm probably going to know that. But what happens is sometimes somebody will do this at 52. And let's say they set up a series of payments at 52, and then at 58 they change something. Because they're like, "I'm almost 59 and a half," and they change the amount somehow.

And if they do that, then they're sunk because then the payments have to actually – they pay the 10% penalty tax on all the money they receive from 52 to 58. And the only exception to that is that there is an option one time where they can switch from what's called the annuity method or the amortization method to the required minimum distribution method without paying a penalty.

But what that does is it greatly decreases the payout amounts. And so that could actually help keep the funds for longer, but it reduces the payout amounts, which usually isn't the goal for early retirees. Which is – incidentally, this is one of the reasons why this Section 72(t) – and I'm going to give you some example numbers here in a minute as we wrap up.

But this is why 72(t) is not really of help for most people. I had a scenario in my practice where I had a client, a wonderful client, and this client came to me and they had a lot of money in their 401(k). And when they had a lot of money in their 401(k), they were doing well, the money got rolled over to my stewardship.

And while it was under my stewardship, the client was doing fine. They had gotten laid off from a job, but they were receiving – what's that called when they pay you money? Unemployment. They were receiving unemployment, and they were just enjoying their unemployment income. They weren't looking for work, and they were just enjoying their unemployment.

This was in the time in 2000-whatever, late 2000s, when it was extended, when they kept extending the unemployment, extending the unemployment. The client was traveling and just not living a big lifestyle, but just enjoying the unemployment. So then – and then had some other savings, and then finally the unemployment ran out after what, it was 99 weeks, I think.

So finally the unemployment ran out. So they just started to think about getting a job. So they went and started getting a job and started looking around and trying to figure out, "Well, what do I do?" They looked at a few different places and couldn't find a job. And then they started taking distributions from the retirement accounts.

It started off as small, and it got bigger, and it got bigger, and it was bigger, it was one, and then four months later it was another, and then it was $10,000, and then it was $40,000, et cetera. And this retirement account goes down, down, down, down, down. The problem was the retirement account – this client was about 50 – but the retirement account – no, no, excuse me, late 40s – wasn't enough to get them through retirement even.

So they said, "Is there any exception?" But we go through 72(t), and 72(t) didn't work because they didn't even have enough money for retirement. So the whole time though they insisted they were going to get a job. If they're going to get a job, they're going to get a job.

So I said, "Listen, you could start 72(t), but the problem is the payments are not enough to fund your whole lifestyle, and if you start at 72(t) you can't change it." Well, the whole point was they needed to go back to work, and they said they were going to.

So it just wound up being a tough situation all around, and it was a massive problem. So 72(t) didn't help. Looking back in retrospect, if I could have predicted what would have happened, then I should have. And that's one of those things where with more maybe wisdom of hindsight, maybe next time if a client is the type of client who doesn't work for two years because they're taking unemployment, and then I should have maybe predicted.

But I didn't know they were going to be out of work for five years, and so 72(t) didn't work. So they had paid the 10% penalty tax. So this is just an example, and the key is you have to actually review the rules and figure out what works in your situation.

Let me give you one calculation, and then I'm done here for today, except I want to actually talk about one problem or consideration with these approaches. So if you actually look at the numbers, and the easiest way to look at the numbers is to just use an online calculator.

I'll put one from Dinkytown here in the show notes that I pulled up. This is easier than calculating by hand. And it'll compare the three different amounts, and you can put in your account balance, the interest rate. It'll stick that in for your age and the beneficiary's age. And then you can choose whether you want to do a single life expectancy or a joint life expectancy or the uniform table.

So if I put in here, let's say that I now am, and it starts at 35, so I can't do it at 30, but let's say I'm a year old, and I put in here that I'm 35 and my beneficiary is 35, and I calculate this on a million-dollar portfolio.

This million-dollar portfolio, basically I could get somewhere about $34,000 per year out of this account. So in my scenario, if I were 35 years old and I had a million dollars invested, and I wanted to take out 3.5% every year, which would effectively be what $34,000 would be, I could use this to actually fund my lifestyle and never have to pay the 10% penalty tax.

I would pay the income tax, but I'd never have to pay the 10% penalty tax if I did that. Now the problem would be that I can't stop it. So if at 39 I change my mind and I go back to work, I can't stop this money, otherwise I have to go back and pay the 10% tax retroactively.

So this is the kind of thing that it could be applicable to an early retirement situation, but it's probably not. You have to have enough money, and an early retiree scenario could do it because they have enough money, but it's probably not because you can't change it. And for me to go from 35 to 60, 59.5, 60, that's 25 years that I've got to predict and I can't stop the money.

Now if I'm okay with just keeping the money coming in and getting it out, that's fine. And so for some people who are trying to say, "I need to cash out my 401(k)," that can work and that can be fine, but you've got to consider it and count the cost.

So those are the four basic options, and depending on an individual situation, many people will choose among those options. Now I want to close with one of these problems. One problem for you to consider. Could the laws change? This is something I rarely see discussed in the early retirement space, but it's a concern of mine.

Could the laws change? One thing I've—I haven't gone back and searched all the legislative history, but I do know this. Laws change. And I have an example here that to me is a good example. I'm going to cover in just a second. But it's very tough for me to trust the government.

It's very tough for me because the legislators who are designing the law are going to be swayed by the court of public opinion. And it's very hard for me sometimes to figure out why certain things are done. So for example, you could hear the traditional mainstream tax perspective of financial planning—excuse me, of tax law—would say that the reason that the government gives you a tax incentive for you to set your money aside until at least the age of 59 and a half is because it's in the social good and it's in the common good for all of us to care for ourselves for retirement.

So there's going to be a motivation for you to set your money aside. Well, it might be a motivation if you just stop taxing people on earning money, but set that aside. So that might be a motivation. Now you could flip it around and say, "Well, is there another reason for this?

Is there a motivation for you to keep your money locked up, for example, to keep you as indentured or enslaved to the working system? Because if you can't get your money out easily, then now you're forced to keep working." What's the answer? I don't know. I could argue either of them.

I'm generally inclined to say it's in the social common—you know, the common social good for the common good of all people because tax theory is actually remarkably consistent. I used to say that tax theory was crazy and inconsistent, and then I actually started studying it and I found out that tax theory and policy is generally applied pretty consistently across all the different taxes and is generally applied fairly evenly.

So I'm inclined to go in that direction, but man, I can acknowledge whether intentional or not the fact that if you keep the money locked up until 59 and a half, it makes it tough for people to get at it. Or is it a way of gaining insight into what people have?

Every year, every single one of your retirement accounts gets reported. The balance gets reported to the government. So there's no chance for privacy in the retirement accounts. There's no chance for privacy. You can't make an investment that the IRS doesn't know about. They know about all of it. Now they could also come and you could do it at a brokerage account if you're trading stocks and they could know about that too.

Sure, they could subpoena that, but it's a whole lot easier if all the papers get sent to them every year. So is that the key? Or was this lobbied by Wall Street? So it's a lot easier to buy mutual funds and put that money in your 401(k) or in your IRA than it is for you to do – you can do a self-directed IRA and invest in real estate, but it's a lot easier to do mutual funds.

So was this a Wall Street issue? I have no idea. I have no idea. I've never found any credible discussion on that one way or the other that was actually credible. If you know of something that would go in one way or the other, let me know. Personally I'm inclined to think it's just social policy because having been involved in the investment business, I see how this is a factor and legislators feel the need to get involved.

They don't just stand there and do something is what they say. I would say don't do something, just stand there. But another conversation for another day. So I've been involved enough, but I've also been involved enough to know there's a lot of industry interest that gets to play. I was involved a lot in the insurance industry and it really bothers me when you go to meetings and you go to industry association meetings and you go to company meetings and it's all about here's what our lobbyist is doing.

Come on. I don't want to be involved where there's a lobbyist, but I understand why you would have to. If I were running a company, guess what? I would have my lobbyists because you have to protect your shareholders or your policy owners if you're a mutual insurance company, but I don't like it.

But I've been around enough to know that guess what? It's the finance industry, it's the investment industry, it's the insurance industry. I don't like it, but it exists. So I have no way of knowing that. But here's the key. Is there a credible reason to think that your plans might get foiled if you become too heavily dependent on one of these strategies?

I think you need to be aware of it. I think you need to be careful. And I'll give you an example of one fairly recent change that was actually from this year that from earlier in this year that affected some people. And the example would be the IRA rollover rules.

And will this happen with conversion rules or something like that? I don't know, but there's no reason why it couldn't. And so I personally am careful about pegging everything on one of these strategies. I would be uncomfortable for me if everything were based upon one of these strategies. So let me tell you about the IRA rollover rules.

The IRS has various rules that allow people to avoid taxes when they're doing IRA rollovers. Many of you have done this when you move money from a 401(k) into an IRA. You left a job. You rolled the money over from a 401(k) to an IRA. So the key is that there are different ways to do it.

Most of the time how this is generally practically done is you do what's called a custodian-to-custodian transfer. The 401(k) provider sends the money directly to your mutual IRA fund, whoever that happens to be. And you never see the money. Now this is also often done where you receive a check for the money, but it's made out, for example, it's made out to Fidelity.

So it's made out to Fidelity for the benefit of Joshua J. Sheets. That's how investment transfers are often done. That's common. But the rule is that the money can actually be distributed to you as long as it's put into an IRA within 60 days. So I could leave a company and I could receive a 401(k) and that money could be sent to me, Joshua Sheets, and as long as within 60 days I put that money into an IRA, then in that scenario I don't have to pay.

It's not actually a distribution. It's a rollover. But I can keep the money out of the IRA, and that's the key for 60 days. Now in order to avoid abuse of the rule, the IRS always said that that was based upon an account-by-account basis. So if you had one IRA account and you rolled it – excuse me, you had two IRA accounts and you rolled one from an IRA at one place to a second IRA, you could still go back to the other IRA and do that one, and they would have separate 60-day windows.

So you could only do that once every 12 months, but it was on a per-account basis. So essentially what you could do is because it was treated on an account-by-account basis, you could set up separate accounts under the IRA rollover and basically chain together multiple IRA rollovers, one after another.

So you do one, and then 60 days later you do another, you do another, you do another. Now how does this matter? Well, let's say you have a million dollars in IRAs, and you're trying to get out $100,000. It works best if it's for a temporary need, but theoretically it could be prolonged.

It's going to get a little bit cumbersome, but theoretically – this is theory – it could be prolonged. So let's say you need $100,000 all of a sudden. Well what you do is you take – and let's pretend that you had the foresight, and in my example you had 10 different accounts.

So you have 10 accounts, each having $100,000 in it. Well you take $100,000 out of IRA 1, and you spend the $100,000. Then 59 days later, you take IRA 2 and you distribute the money from that, and you put money from IRA 2 into IRA 1. And then 59 days later, you do it from IRA 3 to IRA 2, and so on and so on and so on.

So you could see how you could stretch this out. And you're going to have some issues with taxes, because sometimes those taxes are going to be withheld. 20% taxes are going to be withheld, pun of a distribution to you, so you need to avoid that. That's law. Then you also need to make sure it gets done in time.

So there are issues with it, but this is theoretically possible. And this was always a well-known exception among tax law useful tricks. Where you would often see this would be, for example, probably the most mainstream application of this among financial planners would be if you were selling one house and buying another one.

But you needed some money to do a down payment on the second one while you were waiting for the first one to close. So you take the money out of an IRA, you put the down payment on the second house. If you need to, and it goes for more than 60 days, you do this rollover from one to the next to make sure the money's not out for 60 days.

And you go ahead and then when you sell the first house, you put the money back in and you stop the rollover. That was probably the most common. It was a little tool in our arsenal of financial planners to come up with money for a down payment when somebody's trying to come up with money for down payments.

Better than a 401(k) loan. So that changed. And it changed earlier this year with a tax court case called Bobrow v. Commissioner. You can go research this, but Bobrow is spelled B-O-B-R-O-W, Bobrow v. Commissioner. And basically what happened is this guy Bobrow screwed the thing up. He basically botched the transfers.

And so he did it, and I think it was 62 days that it took him or 63 days, something like that. So he didn't get it done. He didn't get it done within 60 days. And he was doing some distributions from IRAs, and it just didn't get done within the 60 days.

So they called him on that. I think it was 61 days. They called him on it, and they took him to court. And they said, "You owe the money for the distribution." And he fought it. But the tax court ruled, and this isn't actually what the IRS argued, but what happened is the tax court didn't rule in favor of the IRS or in favor of Bobrow.

It ruled that the distribution was a taxable distribution because it wasn't done within 60 days, but it actually interpreted the IRS laws to apply to all of an individual's IRAs all at once. So instead of being on an account-by-account basis, which is what the official IRS doctrine was, including publication in their guidance documents as an example of how it works.

I think it was publication 590. Yeah, publication 590, where they actually had examples previously of how this was applied on an account-by-account basis, and the tax court said, "No, this is applied now in aggregate on all IRAs." So it's theoretically possible that somebody could have been counting on this rollover, rollover, rollover plan to get early retirement money out.

I think it would be a lot of hassle. It's not necessarily easy and straightforward, but it's possible. And I think it's instructive. You need to be aware of the example. And then—this is going to be a finger snap—then, there we go, it worked. One tax court case, and boom, it's changed.

So the IRS went back, it changed the code, changed the examples, updated publication 590. Bo browsed out the money, his plan didn't work, and now we have different rules. And there's no reason, in my opinion, why rules can't change. So the Roth conversion ladder, is there any reason why it couldn't change?

I don't think there's any reason why it couldn't change. You would then have to look and say, "Well, is the doctrine consistent with what's going on?" But the problem is that, how do you deal with the winds of public climate? All this stuff is built in these massive pieces of legislation and it brings sweeping changes.

So I mean, a lot of people hear this information and say, "Well, that's it. I'm just not even going to play the game." And I understand it. I get it. A lot of people, however, say, "Okay, here, I'm going to play the game." And most people, what is reality is that most of us wander into this stuff.

You get a job and you wander into your 401(k), you wander into your IRA or your Roth IRA when your dad tells you to do it, and then years later, you're looking at your situation saying, "What do I do?" So my point is that there are various ways around this.

You have to look at it as an individual and say, "What are your assets? What's your asset makeup? What are the risks of your situation versus the rewards? What's the potential savings versus the not?" And you've got to actually look at your situation. There's no way that I'm willing at the moment to make up a generalized broad sweeping statement, but I hope with this information, you can figure out what would be good for you and you can calculate it.

The key with all these things is you need to actually calculate it for yourself. So that's it for today's show. I hope you enjoyed this content. I hope I hit my goal, so you tell me if you liked it or not. Check back tomorrow. I'm releasing an interview with Tammy Strobel from Rowdy Kittens.

We're going to talk about minimalism and how it has helped in her and her husband's financial planning. I think you'll enjoy that. Wednesday, I think I'm going to talk about college planning. I've got openings for Friday's Q&A. I would love some feedback on the Q&A. If you're listening to it, if you're not listening to it, let me know.

I did a two-hour show on Friday with the Q&A thinking that I felt guilty last week when I cut myself off at an hour. I wanted to answer the questions, but I know many of you have trouble with those two-hour shows. I feel like I did an okay job at answering the questions, but it was long because I did a lot of questions.

So I'm still trying to figure out the format here and figure out what's helpful and what's not. Thank you for those of you so far who have signed up for the membership program for the Irregulars. I thank you for it. It hasn't been – well, I dumped probably 70 percent of the audience right when I launched it, so a little hard to know.

It hasn't been enough where I can just quit everything I'm doing now, but it's certainly been a few of you who have signed up, and I really thank you for that, and I appreciate it. If you value the show and the content and the information that I'm bringing, I would be thrilled to have you as a member of the Irregulars.

That is how I've designed – if you like information like this, it's straightforward, it's unbiased, I'm hoping that I can build a membership program that will support the show. I'd love to have you support it. It's $10 a month or $100 a year. Listen, if you don't have the money – I received some feedback from the listeners that I want to support it, but I don't have the $10.

Don't worry about it. Apply the concepts. It's all for free. It's why I'm doing this. Apply the concepts and consider it my contribution to your financial independence. If or when you're able to get to the point where you do have the money, I would be thrilled if you wanted to support it at that point in time.

But if you can't afford it, then don't worry about it. So go buy – if you're interested, go to RadicalPersonalFinance.com/membership. I think that's it for 104. Anyway, go check out the membership program. We'll be thrilled to have all of you to join that. And thank you for listening. I'll be back with you tomorrow.

Thank you for listening to today's show. This show is intended to provide entertainment, education, and financial enlightenment. Your situation is unique and I cannot deliver any actionable advice without knowing anything about you. This show is not, and is not intended to be any form of financial advice. Please, develop a team of professional advisors who you find to be caring, competent, and trustworthy.

And consult them because they are the ones who can understand your specific needs, your specific goals, and provide specific answers to your questions. Hold them accountable for your results. I've done my absolute best to be clear and accurate in today's show, but I'm one person and I make mistakes.

If you spot a mistake in something I've said, please come by the show page and comment so we can all learn together. Until tomorrow, thanks for being here. The holidays start here at Ralph's with a variety of options to celebrate traditions old and new. Whether you're making a traditional roasted turkey or spicy turkey tacos, your go-to shrimp cocktail or your first Cajun risotto, Ralph's has all the freshest ingredients to embrace your traditions.

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