Early retirement is something many people dream about. They might have enough money in their savings to live on, but there are tax disadvantages to consider before deciding to move ahead with the goal.
Here are five possible tax disadvantages when taking early retirement:
All the money that’s been invested in such qualified retirement plans as IRA and 401(k) accounts using pre-tax dollars is subject to income tax as soon as it is withdrawn, Investopedia explained
. Withdrawals before age 59 1/2 are subject to income taxes at the regular rate plus a 10-percent penalty. Early withdrawal of money from other investment instruments, such as certificates of deposit, may result in additional penalties.
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Social Security retirement benefits are available at age 62 for early retirement with about a 25 percent reduction in the payment amount, which could cause tax disadvantages, according to U.S. News & World Report
. When money is withdrawn from IRA or 401(k) plans, that income is combined with a person’s Social Security retirement benefits to determine whether the Social Security is taxable.
People may avoid withdrawal penalties by setting up substantially equal periodic payments from a retirement plan, Investopedia said. However, the arrangement is irrevocable and they will lose control of how much and when the money comes to them. Changes in a person’s financial situation may cause this action to bring disadvantages.
A serious disadvantage to early retirement is the cost of health care, Forbes reported
. Medicare is not available until age 65, and COBRA through previous employers lasts only 18 months. One option is to purchase health insurance through the Affordable Care Act exchanges. Eligibility for subsidies to the cost depends on a person’s taxable income. A health savings account (HSA) could provide tax-free distributions to pay for medical care.
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Where a person lives could cause tax disadvantages, U.S. New & World Report said. State and local taxes, cost of living, sales taxes, and other costs can have a big effect on retirement income. Some states have no income tax and some states have significant income tax.
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