Payout options for those who can't wait to retire

It is one of the best-kept secrets in personal finance: Despite protestations to the contrary from the companies that market Individual Retirement Accounts and 401(k)/403(b) contributory retirement plans, you can cash out part or all of an account long before your so-called "eligibility date."

That date is usually when a person turns age 59-1/2, at which time retirement-account holders can begin taking withdrawals without fear of being penalized with at least a 10 percent tax on the amount withdrawn.

Yet what is not generally explained is that you can actually go into a contributory retirement account and take cash withdrawals - without penalty - at any age.

There are guidelines you must follow, however. First and foremost, you must establish a withdrawal plan and stick to it for at least five years, and until you reach age 59-1/2. That means that if you start taking withdrawals at age 50, you will have to do so on a regular basis for about 10 years. If you in any way change your withdrawal schedule, you will be socked for the 10 percent penalty plus interest. Moreover, the penalty will become retroactive to all the withdrawals you have already made.

"People who elect to take [early] distributions may have a lot of money in their account and just want to live a little," laughs Barry Picker, an accountant and IRA expert based in Brooklyn, N.Y. "Or, for one reason or another, they may actually need the money."

People who want to make penalty-free withdrawals, must also follow one of three distribution methods:

1. Life-expectancy method

Start by getting IRS Publication 590, "Individual Retirement Arrangements," which can be downloaded for free at www.irs.gov. The publication contains a table of life-expectancy charts, depending on your current age. Let's assume you are 50. Under IRS calculations, you will likely live another 33.1 years. You then divide that number into the total value of your IRA.

If the IRA is worth $200,000, you can get a first year, tax-penalty-free cash out of $6,042; the next year, you would divide the remaining amount in your IRA by your new life-expectancy date. You would repeat this procedure each year until you turn 59-1/2. You can also use this method by computing the joint life expectancy of the account holder and beneficiary.

2. Amortization method

Here, you calculate a reasonable rate of return on the amount of money in your account. This allows you to take out a much higher amount than would be the case under the life-expectancy method.

3. Mortality-table method

This is generally considered the most complicated of the three approaches. Here, you convert your withdrawals into annuities by using an insurance mortality table and assuming a reasonable interest rate.

A good article on these three accounting methods can be found on Mr. Picker's website (www.bpickercpa.com). Under "recent articles." click on "Annuitizing and IRA."

While IRA holders can begin early penalty-free withdrawal regardless of their employment status, the rules are different for holders of 401(k) or 403(b) plans. In this case, "you must have left the employer with whom you have the account before you can begin the early withdrawals," Picker says. You must also gain the approval of the plan administrator. (That is usually automatic in the case of IRAs.)

One alternative, says Picker: Roll the 401(k) or 403(b) into an IRA, and then make the withdrawals under one of the three approved accounting methods. The advantage of leaving your assets in a 401(k) plan, however, is that they have greater legal protection from lawsuits than do assets held in an IRA, Picker says.

While sellers of contributory retirement accounts may play down these early withdrawal strategies, they are up front in explaining other ways that you can cash out tax-sheltered retirement accounts without facing penalties.

In the case of traditional IRAs, you can take a penalty-free withdrawal if the money is used for medical bills that exceed 7.5 percent of your adjusted gross income, medical insurance when unemployed, a house for yourself or other close family member (up to $10,000), or for higher education. You must still pay taxes on the qualified withdrawals, however.

In the case of Roth IRAs, you can take back your contributions without penalty or tax at any time. They were nondeductible to begin with. You have already paid a tax on them. If, however, you moved money from a traditional IRA to a Roth, the assets must stay in the account for five years before you can take a tax-free conversion.

Earnings on Roth IRAs can also be withdrawn tax-free, providing you have reached age 59-1/2 and the money has been held for at least five years. You can also withdraw tax-free earnings if the contributions have been held at least five years and the money is used for a home, or you are disabled,

Most consumer specialists, however, advise against prematurely cashing out IRAs or 401(k) plans. "These are the best places to put money for tax-free growth," says Stephen Pollan, author of "Die Broke," (Harper). "They provide income protection for when you will most need the assets," namely, in your later years."

(c) Copyright 2001. The Christian Science Publishing Society