First, it depends on what kind of IRA you have. The rules differ for Roth IRAs. Second, it depends on whether you retire before or after age 59 1/2. For our purposes, we are going to assume retirement occurs before age 59 1/2.



What Income is Taxable?

The first issue is to be clear on are the rules as to what IRA withdrawals are taxable income. With traditional IRAs, the answer is easy: All income is taxable. However, if you made non-deductible contributions to a traditional IRA, SEP or SIMPLE IRA, distributions are prorated. Any deductible contributions and earnings are taxed; your non-deductible contributions come out tax-free, inasmuch as you have already paid tax on them.

Distributions from Roth IRAs are treated as coming first from your contributions and then from earnings. In addition, Roth IRAs have a "qualified distribution" rule. The first hoop to jump through is to have had your Roth for five years. The five-year clock starts running when you make your first Roth contribution. If you have satisfied this five year rule, are under age 59 1/2 and disabled, you can take out contributions, as well as earnings, tax-free.

The 10% Early Distribution Penalty Tax

Withdrawals from IRAs that are includable in income and taken before age 59 1/2 are subject to a 10% early distribution penalty tax unless an exclusion applies. Note, as per the discussion above, that contributions to Roth IRAs are not includable in income when withdrawn.

Here are the exceptions:

1. Death. Granted, this is not the best way to start your early retirement, but it is an exception.

2. Disability.

3. Withdrawals that are a part of what are referred to as "substantially equal periodic payments" (SEPPs). Using this approach is one of the most viable solutions to early retirement and a subject all to itself.

4. Made for medical care. However, this is limited to rules on the deductibility of such items, which currently applies to those medical expenses in excess of 7.5% of your adjusted gross income.

5. For the payment of health insurance premiums, but only if you are unemployed.

6. Made to pay for qualified higher education expenses. Not only could you go back to school, but this also applies to your spouse, your children or your grandchildren.

7. Made for first time homebuyers. It isn't likely that you are hunting around for your first starter home, but this also applies to your spouse, your children or grandchildren. The limit, however, is $10,000.

8. Made to a reservist while on active duty. This is a new exception included in the Pension Protection Act of 2006. The exception period is after 9/11/01 and before 2008.

Now that you are armed with this information, I hope that you are in a better position to assess the viability of retiring early. I would recommend becoming familiar with the options available under the substantially equal periodic payments exception. These may be the key to your early retirement.