Learn how to build an income bridge to early railroad retirement.
Welcome everyone to another edition of the Highball Advisors Railroad Retirement Whiteboard. My name's John McNamara of Highball Advisors, and today we're going to talk about examples of railroaders. They might have their 30 years in their 50s, and they say to themself, "Okay, I got my 30 years, I'm leaving. Oh, by the way, I don't have enough money yet to bridge those years until I get to 60 where I can collect my full railroad retirement annuity." How can you get there? There's a lot of different ways. I want to show you one way here called 72t. Now, this is a very complicated and dangerous, I always say that, from a tax perspective because there's some penalties and rules there, but there is a possibility for some railroaders to at least take a look at this. I'd thought I'd walk through this here.
What I'm talking about is those who have tax deferred accounts, 401(k)s and IRAs, there's 10% penalty if you take a withdrawal before 59 and a half. For certain 401(k)s, you can actually, if separation of service, you can take at 55. But for this example, let's just say 10% early penalty withdrawal for anything at 59 and a half. You're saying to yourself, "Geez, I got all this money tied up in my retirement account. I'm retired. I need to find a way to access this because I don't want to pay this 10% penalty." That's the purpose of 72t. All right.
What is it really? The definition, it's a series of substantially equal payments, 72t. It's basically an annuity to get you to railroad retirement. Equal payments each year to get you to retirement. It's IRS rule for those scoring at home. Section 72t, subsection four, subsection a. There you go. Now, the rules are annual distributions for five years, you got to take it for five years, or until 59 and a half, whichever is longer. Whichever is longer. You know you're going to be taking it out for at least five years. If you retire at 50, say I got my 30 years at 50, you're going to take it for 10 years. All right. Those are the type of things that you want to be thinking about.
Now, there's three methods and I'm not going to get into the math of these methods. But there's three methods to show you how much you can take out each year without incurring the 10% penalty. There's the RMD method, requirements, amortization and annuitization. Those are the three method methods. You can drill down deeper on those with the IRS on those methods. Needless to say, they're there for you.
Let's just go through an example. This is a great way to learn how to do these things. Let's say a railroader is 50 years old and he's got his 30 years and he's leaving, and he's got a million dollars in his 401(k) or IRA. I put IRA in this case. Now, he's going to take that million dollars and crunch the three methods to see how much he can take out that's going his lifestyle. You might not need too much, and he might need a certain amount. That's why you want to do all three methods and figure out which is the right amount of income that he needs. Maybe the spouse is still working, so he doesn't need as much money. You want to figure that out.
In this example, he reviews it and says amortization method is going to give him $60,000 a year, $60,312, and that's going to last him until he's 60. He's going to take those substantial equal payments until 60 for 10 years at $60,312. And then, he is like, "Okay, great. Now, I'm at railroad retirement. I've got that money coming in." All right. Now, what does he got to look out for? Well, you got to be on guard for the pitfalls, that type of thing. That money gets taxed at ordinary income so it's not tax free distribution. This is going to get taxed. All right. That's first one.
Now, this one's very important. 10% penalty on all distributions if you missed one. Going back to this fellow up here, let's say he's 57, he's been doing it every year, and then at 58, he missed it. I didn't do the payment. I don't need it any more. Wrong. They go back and they're going to charge you that 10% penalty on his 50 year old, 51, 52, 53. Oh my God. That's 10% on this distribution every year, 6000 times seven years. That's $42,000 tax bill coming his way. That's not good. Very, very important. You got to do it every year. That's that disciplined approach.
And then, this one's also, let's say, "Well, I've retired and now I'm going to go back to work here so I don't need this money coming in." Wrong. Can't do that. If you go back to work, you must continue. That's a pitfall, because now, remember, you're drawing down your retirement nest egg and you're going back to work. This strategy is a bridge that's there. I would highly recommend you don't do it on your own. Work with your financial advisor because of all the penalties and things like that. You're going to have to be very committed to this if that's something you want to do, especially if you're going to go back to work. Miss these penalties.
I just wanted to show you that there is a bridge to get you to that early railroad retirement, for those who don't want to work any more and waiting to get their railroad retirement annuity turned on. I hope you found this helpful. Reach out to me if you want to discuss this. Or if you're nearing retirement and you want to talk about going through the boarding for railroad retirement process, really great information that you'll get on what your retirement income's going to look like in railroad retirement, or even if you're in retirement.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. Highball Advisors encourages you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Highball Advisors, and all rights are reserved from Highball Advisors, and all rights are reserved.