Backdoor Early Retirement: Anyone can tap their 401k or IRA for early retirement without paying a penalty via SEPP / rule 72t

WARNING – Use this advanced technique with extreme caution!

*** This is an advanced, somewhat complicated technique wrought with peril. Consult a tax advisor and use very carefully, if at all. ***

As a financial advisor, I often stress that you cannot save ‘too much’ in a tax-advantaged retirement account. Even though you generally can’t touch your IRA or 401k earnings without paying a 10% penalty until you’re 59.5 years old, there is an option to get at that money and avoid this penalty. Because of this option, it usually makes sense for everyone to max out their tax-advantaged retirement savings before they invest in a taxable account, even if they a) want to retire early (pre-59.5) AND b) they have very little in non-retirement savings.

The IRS has a rule called 72t that allows you to request ‘Substantially Equal Period Payments’ (SEPP) for at least 5 years or until you’re 59.5, whichever time period is longer (so, age 59.5 for most early retirees!)

(There’s another option which I’ll cover later called the ‘Roth IRA conversion ladder‘ which involves moving your 401k/Trad IRA to a Roth a bit at a time each year, waiting 5 years from the first year you do this because the IRS requires it, then taking withdrawals of the contributions you rolled over 5 years earlier.)

closed white wooden cabinet
You too can sneak in through the backdoor.

How SEPP / rule 72t works

The basic idea is that the IRS lets you take ‘substantially equal payments’ from your Traditional IRA each year– or each month– whenever you want to start them. These payments must continue for the greater of 5 years or from when you turn 59.5, and there are severe penalties if you change your mind. You are also very limited on how much of the money you can get your hands on, since the IRS wants it to last until you die. However, the devil is in the details, so read on!

The IRS has a handy FAQ on the SEPP which you should also read. Forbes also sums it up nicely.

Leisurefreak sums up the rules, and the very scary downside if you mess things up:

Once you begin SEPP payments you cannot add to that SEPP IRA or take more money from it for 5 years or age 59 ½, whichever is longest. It is best not to commit all of your IRA funds to a SEPP. That way you have side emergency IRA money outside of the SEPP.

There are 3 different methods to calculate payment and the IRS has restrictive rules for the payment amount. The SEPP IRA amount is based on your age, gender, and the long-term bond rate at the time of establishing the 72(t) SEPP.

Work with a qualified tax professional or financial adviser to correctly set up the SEPP. If at any time you deviate from the substantially equal periodic payments within the IRS guidelines, you may have to pay the 10% early withdrawal penalty going all the way back to day one.

You first need to decide how much money you want to tie up in your SEPP IRA. Once you allocate the money to be paid to you in SEPP form (roughly equal payments for at least 5 years or until you’re 59.5), you generally cannot change this amount. So, you need to think very carefully about how much you want to lock up in the SEPP, and how much income from this SEPP you want to receive (dependent on your market returns during the life of the SEPP.)

First, look up the maximum interest rate you can use by using the last two months prior to the month you’re going to start the payments. Choose whichever of those two prior months had the higher rate if that’s your goal.

Then, plug that rate along with your other info, including the size of the IRA you’re going to use into a 72t calculator like this one from Bankrate to get your fixed dollar payment number as a monthly amount. (Or, start with the dollars you need and then back into the account size of the IRA you need, and move money from your other IRA(s) or rollover your 401k to fund the IRA that you’re going to use solely for your SEPP.)

Here’s a screenshot for a 50-year old person who plans to use $500,000 in IRA funds and chooses the single-life expectancy method, which yields the highest payout possible if you also choose the ‘fixed amortization method’:

Note that ‘beneficiary age’ (e.g.: your spouse) doesn’t affect the calculations for ‘single-life expectancy’. Your marital status and age of your spouse seems to determine which method you must choose. Consult your accountant!

This says our hypothetical 50-year-old could start taking annual payments of nearly $18,000 on a $500 K IRA that they designate for SEPP use, which is about $1,500 per month. Not a lot to live on, but it could make the difference between retiring early vs continuing to have to work full-time if you have other income sources.

How do you set up SEPP payments from your IRA?

You could pay a financial advisor or CPA who is knowledgable about this to set one up for you if you’re daunted by the math. I’m a big DIY guy when it comes to finance, and I’m a financial advisor, so personally I would feel comfortable running the numbers, dividing the annual amount by 12 months, and setting up an automated withdrawal for that amount from my (SEPP-earmarked) IRA at Vanguard.

What investments should you choose?

You can change your investments as you go, just like you can with any IRA, but I would recommend something tailored to your current age and overall risk tolerance. A target retirement fund matching the year you turn 59.5 might be a good choice (e.g. the Vanguard Target Retirement 2030 fund for our 50-year old in 2021), but you should do some hard thinkin’ on this or consult a financial advisor.

What if you run out of money before you turn 59.5?

Well, you run out of money for one thing and therefore don’t get anymore SEPP payments. The good news is that the IRS won’t consider that a violation of the 72t rules and will not assess you a 10% penalty + interest going back to your first payment like they would if you chose to discontinue payments prior to 59.5. (Per this IRS source courtesy of Leisurefreak. But check with your accountant on all of this, including this scenario. I am not a CPA!)

The other good news is that you can do a one-time switch of accounting methods from the fixed-dollar methods (fixed amortization or fixed annuity) to the more flexible RMD method where your withdrawal amount will change annually based on your account balance (and life expectancy.) This might help you reduce your withdrawals if the market tanks, but of course it doesn’t help your income needs.

Should you actually do this?

The SEPP is a way for people who do not have enough income + Roth IRA contributions + taxable investments to retire early (pre-59.5) but would still like to do so. If you’ve been maxing out your 401k all along, but saving little else, this might be you.

My preferred solution to early retirement– and the one I’ve been lucky enough to accomplish by the time I turned 38– is to just max out your retirement accounts and THEN save a lot in your taxable accounts, using these until you turn 59.5 and can tap your Traditional IRA/401k. However, this requires enough income-net-of-expenses-taxes-retirement to be able to do it. For most people reading this will mean making over $100,000 a year at least for many years. Fortunately, most people reading this are exactly in that situation and could do it if they cut their spending and used the Better Tomorrow Financial banking system.

Credit: wrote a few excellent articles on how he used a SEPP IRA to fund his early retirement. I’m using his term ‘backdoor early retirement’ as a great way to describe this technique.

Avoid these 8 common financial mistakes

TL;DR – Avoid buying these things:

  1. cash value aka Whole/Universal Life insurance (buy term life instead),
  2. annuities
  3. credit card debt (pay it off now & set up autopay)
  4. car leases
  5. time-shares
  6. a new car before your old one is completely done for.
  7. Generally avoid buying vacation property or
  8. expensive remodeling your home, at least until you have $1+ million in the bank or are otherwise ready to retire comfortably and have extra money to burn.

Having advised a lot of people financially, I see the same mistakes holding them back over and over again. These bad decisions don’t seem to be bad moves to people at the time they make them, which is why they are so dangerous. The combination of friendly salespeople serving their wicked corporate overlords + our consumer culture makes wealth-destroying behavior seem ok and normal to us. It’s not ok, and it’s harmful, so let me help you recognize it so that you can avoid it and grow wealthy. Your future self will thank you.

Financial mistakes ordered from ‘Absolutely-Do-Not-Do’ (1 – 5) to ‘Be Careful’ (6 – 8)

  1. Buying ‘cash value’ life insurance like Whole or Universal Life insurance. 99.8% of people only need Term Life insurance, and that is what you should buy. If you think you’re in the 0.2% that could benefit from a cash value life insurance, you are almost certainly wrong, even more certainly if you’ve been convinced of this after talking to a salesperson who might be thinly, or thickly, disguised as an ‘advisor’ or some other financial person deserving of your trust. Most are absolutely not. Trust no one. Not your bank, not your credit union, not your mom, not your co-worker, and definitely not anyone who works for a financial institution or gets any type of payment from them. Trust no one. Except us, we’re the good guys.
  2. Buying an annuity. Life insurance companies are again the villains here. They push annuities to people who are afraid of ‘losing/running out of money’, which is… everybody. In reality, only 0.0001% of the population would probably ever truly need an annuity, and even this tiny fraction could find a better one than being offered by your particular salesperson. Pricey annual fees sneakily included so you don’t see what they cost you combined with all kinds of heinous other fees to prevent you from getting out of the product will steal a ton of your money over time. To illustrate, $100,000 invested in 0.1% fee stock index fund over 30 years will generate income of $508,000. In a typical 2%-per-year money-stealing annuity (it’s often even worse), you’ll only get $247,000 over the same 30 year period with the exact same investment risk, less than half as much! Where did the missing $261,000 go? Straight into the saleperson’s and the insurance company’s pockets. They’ll be quick to emphasize how wonderful it was that your gained $247,000, and if you hadn’t read this you would have never known that you actually lost $261,000 thanks to their evil machinations.
  3. Not paying off credit card debt when you have the cash on hand to do so, and not setting up autopay. This one baffles me a little since everyone ‘knows’ that credit card debt is ‘bad’, and yet even when they have cash in a checking account making nothing they sometimes don’t take it to pay off credit card debt costing them 12+%. This behavior is correlated with people who don’t enroll in autopay to always pay off their credit cards in full every month. The best way to avoid this problem is to log into your credit card account(s) RIGHT NOW, and turn on automatic payments for the full balance. Seriously, do it now. Here are the links for Chase, Capital One, Bank of America (instructions here), American Express, Discover, and CitiBank. If you’re carrying debt, transfer any cash you have on hand to pay off the balance right now (the same links above probably get you close to the right place to make a one-time payment. Do this now too!) With autopay, you’re not losing any control or risking a bounced payment because you’ll still get all the same notifications of a bill about to be paid and can always log back in later and turn off/reduce your autopay to a less-than-full amount if needed. You can still check your statement 20-something days prior to your bill being due in case there’s some charge you want to dispute, which there won’t be, because yes, it turns out that the suspicious SAM’S SUPER DUPER 1000 COMPANY charge for $38.93 that you don’t remember and are positive was fraud was just some gas station somewhere that you did indeed fill up at. One urban legend I’ve heard is that it’s “good for my credit score” if you run a ‘small’ balance. This is 100% false. On the contrary, paying your bills on time every time without fail is the best way to maintain a high credit score, so again, set up automatic payments for the full balance amount right now! There’s no danger, and much goodness, in scraping together all cash you have on hand to pay off an outstanding balance now. In the worst case scenario, if you need cash later, you can simply run up the debt again back to where it was.
  4. Buying a time-share. This is another ‘sold-not-bought’ product that you will almost certainly not get enough value from. They come with annual fees, are difficult to sell, especially for any kind of money close to what you paid for it, and make you feel forced to use them even if you’d rather do something else with your vacation time. Just rent a hotel/AirBnB like everyone else and you’ll enjoy more freedom, and almost definitely more wealth.
  5. Leasing a car. Unless you absolutely must have a new model all of the time, or can wangle some business tax deduction that your accountant has actually run the numbers on and assured you it’s worth it vs buying (it’s probably not even then), leasing a car is a wealth-destroying move. Instead, buy a reasonably priced, reliable car and drive it into the ground.
  6. Buying a new car before your old one is used up. Like leasing, buying another car before running your current one into the ground is a very costly thing to do, especially if you repeat this process many times during your life. Whether you choose to buy used cars as I recommend, or if you must have a new car, always drive your current vehicle into the ground before upgrading. This saves you a lot of money by driving your car long after you’ve paid it off. Switching cars every few years is a good way to burn through a lot of disposable income that you otherwise could have invested and become wealthy with. One simple rule to avoid temptation is always paying cash for your next car. This forces you to save for it in advance, and also to reckon with the true cost of upgrading as opposed to fooling yourself into thinking it’s not that financially painful by financing it in little bits each month. Rule of of thumb: Spend less than $10,000 for your next car, and only upgrade when your current vehicle has > 200,000 miles on it or would cost more than half its value to keep driving it.
  7. Buying vacation property. After time-shares, this is another popular way to sink money into something that you will never ever get enough value out of. Anytime you consider buying a vacation property, take the purchase price, and multiple by 5%. Write down that number, and decide if this annual ‘opportunity cost’ is close to the annual value you’d get out of your property. Consider a $300,000 remote lake-front cabin. Sounds nice and peaceful right? Well, 5% * $300 K = $15,000 per year, which is $1,250 per month. That’s roughly how much more you’d make over time on that money if you invested it in a low-fee stock index fund instead. Let’s say you spend a month per year at this resort of yours, which is pretty darn optimistic for most working people. 30 days divided into $15,000 = $500/day. For that price, you could rent a room in the Bellagio in Las Vegas and order champagne room service every day. You are not getting a good deal on your vacations spent at Lake Woebegone. Plus, if you buy a vacation place, you’re gonna feel obligated to ‘get your money’s’ worth and feel pressured to go there every time you have vacation. Maybe you’d rather go somewhere else instead! $15,000 per year can buy a lot of hotel or AirBnB stays, or an annual multi-week European vacation, or anything else you can think of, including a very nice lakefront resort property that you don’t have to own and can instead rent as you like! Vacation property is almost never worth it from a financial perspective. Even if you plan to rent it out part of the time to get some money back out of it, the math usually doesn’t work when you subtract the cost of the mortgage, taxes, insurance, property management and other fees, and maintenance from the revenue you expect (which always ends up being less than you think.) There’s also the headache associated with managing and maintaining property of any kind, which is even worse if you’re also a landlord. If you must buy vacation property, try to get it so cheap that even if you only use it a few weekends out of the year (the most likely scenario), your per-night/annual costs are still reasonable. For example, getting a few acres of raw wilderness land for $20,000 that you could camp on, or even erect a cheap tiny mobile home for another $20 K, might be worth it. 5% * $40,000 = $2,000 per year. 10 nights a year = $200/night, not bad, and the land might even someday increase in value if you buy it in a nice area that is experiencing population growth (but don’t hold your breath.) Rule of thumb: Spending less than $100,000 for vacation property, maybe it’s ok. More than $100,000, DON’T DO IT!
  8. Remodeling your home. People love to spend on their homes by telling themselves ‘it’s an investment’. Every single remodel/addition listed here shows that the value of your house will increase by less than the cost of the remodel. Think about that. As soon as you’ve spent $20,000 remodeling your bathroom to your unique tastes, maybe your home value when you finally sell the place has increased by $10,000, so you’ve instantly destroyed $10,000 in wealth. If that $10,000 loss was worth it to you because you love your new bathroom by that much over the life of the time you spend in the home, that’s fine, but don’t fool yourself into thinking you’re gonna recoup anywhere near the spending in a future home sale. Of course, there are some price-effective home improvements that you should do like adding insulation to save on energy costs, but these tend to be few-hundred dollar DIY projects that no one sees, vs $10,000+ projects that you pay other people to do and then show off at parties. Houses do not build wealth anywhere close to stocks, and the same goes for remodeling them. If you are skilled and can do a lot of the costly labor yourself and scrimp on materials costs, you might be able to add some ‘sweat equity’ to your property as well as enjoying the results of your labor. That said, even skilled people in my experience end up spending much more than the value they create. Rule of thumb: If your home improvement projects total less than less than $10,000, go ahead, otherwise DON’T DO IT!

Any other common financial mistakes that you’ve made, or seen other people make, that you think should be added to the list? Let me know in the comments.

Affordable health insurance for the self-employed and early retirees?

I intend to retire early, and thus one of the challenges my family will face is what to do about health insurance until we’re 65 and can enroll in medicare. We have one kid already, and thus will need care for ourselves as well as children. We’ll have too much money to qualify for a subsidized Affordable Care Act (ACA aka Obamacare) insurance plan, and as of 2020 catastrophic health insurance is at least $1,000 per month for a family, and offers crappy coverage and high deductibles on top of the tens of thousands in premiums we’d pay.

On the plus side, we have been saving a good chunk in an HSA, which I recommend everyone take advantage of while working, so we can at least use that for out-of-pocket expenses.

One of us could work at least part-time to get subsidized insurance benefits. Another intriguing option is Direct Primary Care, where you pay a monthly fee (say, $100 or so) per month for primary care doctor’s visits and basic services (which might cost extra). DPC avoids insurance altogether, making both your life and your doctor’s easier.

While a DCP would cover the basics like labs, check ups, vaccinations, and maybe even bone-setting, what about surgery or other low-probability but extremely expensive hazards? To handle that, take a look at ‘health sharing’, an insurance-like membership plan to will reimburse you for health expenses after a (large-ish) deductible. Think of it as simpler, cheaper catastrophic health insurance, which you get a discount on if you also belong to a DPC.

Until I do more of my own homework, I’ll let my favorite financial blogger Mr. Money Mustache explain the DPC + Health Sharing concept, complete with links to find providers of both that you can check out for your own needs.


Mr. Money Mustache recommends Sedera for health sharing. For Direct Primary Care, try this map to find a provider near you.

You can compare the pricing & services providing by this combo of plans to traditional private health insurance by getting a quote at, and also search for the health insurance exchange options.