How to Retire Early on a 401k With No Penalty. Normally, if you withdraw money against your 401k retirement plan before the age of 59 1/2, you pay both income tax on the withdrawal and a 10 percent penalty. However, if you're looking to retire early on a 401k with no penalty, you can sidestep it by drawing out the money in what will be considered "substantially equal payments" spread over the remainder of your life.
Divide the amount of equity built up in your 401k by the number of years remaining in your life expectancy. For example, if you are 50 years old and have $250,000 in your 401k, your life expectancy will have approximately 25 years remaining, for a penalty-free withdrawal of $10,000 per annum.
Visit your bank or financial advisor to discuss setting up an annuity plan that would see you withdraw the required amount of money each year.
Continue to receive your annuity without adjusting the amount you are paid each year, unless it is absolutely necessary. If your payments drop below your established threshold, the Internal Revenue Service will come looking for the 10 percent fee you're trying to avoid.
Retire on your 401k early by waiting until you're as close to the age of 59 1/2 as possible. Not only will that increase the amount of your annuity, it will also make it easier for you to adjust the amount of the annual payment downward with no penalty. IRS regulations state you will face the 10 percent penalty if you adjust the amount of the annual payment within the first 5 years of your plan, but you are exempt from this technicality after the age of 59 1/2.
Factor marriage into the equation. If a married couple decides to withdraw annual payments together and one spouse passes away, the rules change. If the deceased was aged 59 1/2 or younger, or if the payments had been taken for at least 5 years, the surviving member of the couple is entitled to readjust the payments with no penalty.
"Substantially equal payments" is not the only way the Internal Revenue Service will permit you to take money from your 401k with no penalty. If you have significant medical expenses, want to make a down payment on your first home or suffer a disability, you might also qualify for penalty-free withdrawal of your 401k equity. Remember that life expectancies are determined according to actuarial tables if you plan to use your 401k to retire early. Your remaining life expectancy is determined by the financial institution, not by you.
You must draw money from your 401k every year, or your previous drawings may become subject to the 10 percent penalty, as well as income tax arrears.