If you withdraw money from your IRA, 401(k), SEP IRA, or other qualifying plans before the age of 59 ½, you will be subject to a 10% tax penalty. If you make “substantially equivalent periodic payments” [SEPP, also known as the 72(t) exception] or qualify for another more limited exception, the penalty is waived. The IRS established the base interest rate in January as “an interest rate not exceeding 5%.” That implies you can borrow more money without penalties and have more predictability. Guaranteed Income With A Fixed Annuity You’ll need a plan that will generate consistent income over the years and make payments. Dividend-paying stocks and bonds are an option, but the income will fluctuate, and you may have to dip into your principal if markets fall. However, a fixed-rate annuity can provide guaranteed interest income and access to principles, subject to the annuity policy requirements. It’s similar to a bank’s Certificate of Deposit (CD) in that it’s underwritten by life insurers and pays a fixed interest rate for a specific period. On the other hand, fixed annuities typically pay more rates than CDs with the same period and provide more penalty-free liquidity. Consider the following scenario. Bob, who is 50 years old, decides to retire early. In his IRA and 401(k) accounts, he has $1.6 million, and he wants to take out $50,000 every year. He sets up $1 million for his SEPP with fixed amortization. He could draw essentially equal periodic payments of up to $60,312 a year from that $1 million—the most he could take, based on his life expectancy and the IRS-defined 5% base interest rate. However, Bob chooses a more conservative lower amount because that sum exceeds his income demands and would leave him with less principle after ten years. He purchases a $1 million 10-year fixed annuity with a 3.5% annual interest rate from an AM Best-rated company. Even though the annuity pays less than $50,000 in interest per year, he will receive $50,000 each year because the IRA annuity he chooses allows for penalty-free withdrawals of up to 10% of the account value each year. As a result, it can easily accommodate Bob’s $50,000 annual payments at the start of each contract year. Security Of Annuities Fixed-rate annuities, unlike bank CDs, are not insured by the FDIC. On the other hand, state insurance departments closely regulate life insurers for solvency. Furthermore, in the improbable event that the insurer becomes insolvent, state guaranty associations protect annuity owners up to a specific limit. Bob should either split his money among multiple annuity companies (which isn’t a problem) or go with only a highly rated insurer or insurers because no state association provides $1 million in coverage.
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