The human condition drives people to avoid penalties with all their might. From sports to taxes, dodging fines is simply in our DNA. But sometimes, Kevin Canterbury of Arizona says paying can be worth it to increase assets and secure a wealthier future.

Investment-hungry individuals realize the potential of incurring an IRA penalty on purpose. The trick appears to be paying at the right time, as showcased by this middle-aged couple, Grant and Wendy.

A Brief Background

Grant and Wendy were a run-of-the-mill couple in many ways. They earned decently, but everything they made fluttered away to pay for three children and a mortgage.

Despite that, the couple was diligent with their finances. Wendy had a traditional IRA worth $30,000. Grant had a 401(k) filled with $200,000 and $40,000 in an IRA.

When questioned, Grant stated he accumulated much of this wealth “ahead of time.” He mentioned, “Wendy and I used to live in a smaller home. It allowed us to save larger chunks of our salaries every year. Plus, my 401(k) plan came with a generous match offer, which has got us this far.”

The IRA Penalty Debate

However, the couple’s situation shifted. As their economic environment became tighter, Grant stopped contributing to his 401(k) plan.

When speaking to a financial planner, he stated that continuing to contribute would force him to take money from elsewhere to pay the bills. Ultimately, he didn’t want to touch his $35,000 savings account unless it was an emergency. After that, the only other place he could tap into was his IRA.

So, Grant contacted his CPA to discuss accessing the money held in the IRA but was quickly put off by the idea when told the distributions would be subject to a 10% penalty and regular income tax.

And thus, the IRA penalty debate begins.

Innately, the decision to avoid the penalty makes sense. However, they were missing a potentially substantial wealth-building trick:

Restart 401(k) Contributions and Pay the IRA Penalty

When advised to restart $5,000 salary deferral contributions per year (matched by Grant’s company), he was initially distraught — the thought of paying income tax and a penalty on his IRA distributions was simply too much.

But by taking a step back and looking at a longer-term picture, all became clear.

The deferrals lowered his income, ensuring his IRA distributions did not affect his income tax payments. Plus, he had an extra $10,000 in his 401(k) growing tax-deferred. True, he owed a $500 penalty that wasn’t canceled out by the 401(k) contribution. However, he began to view that as the cost of having a larger retirement fund.

The trade-off is marvelous.

The Crux: Thinking Big

Estate planning, penalties, and taxes aren’t black and white. So while a general understanding of big-picture tax issues is essential, avid retirement savers should consult a financial advisor to determine whether purposefully paying the IRA penalty makes sense.

Many believe taking pre-59 distributions is never a good idea. But Grant and Wendy’s situation highlights that the word “never” doesn’t apply to paying the IRA penalty. 

If you ask any individual approaching retirement what their greatest fear is, 95 percent will answer that it’s outliving their income. While this worry is not baseless, it is important to note that the most significant factor that will impact anyone’s ability to live on their retirement savings is their life expectancy. Whether someone has saved 50,000 for retirement or 5,000,000, their lifespan will dictate whether or not they will be able to live off these savings. Although 100 years ago, it was not uncommon for someone to live five years past their retirement, today, Americans’ life expectancy is at an all-time high. As a result, longevity has become a buzzword in retirement planning in recent years. Kevin Canterbury, Managing Director at Redstone Capital Management and lifelong Arizona resident, says that although it may be uncomfortable to discuss, those planning for retirement must complete a life expectancy analysis. Kevin Canterbury stresses to readers that a life expectancy analysis is the best way for retirees to set a sufficient goal for their retirement savings.  

Estimate for Longevity 

Today, the Social Security Administration states that a mean who reaches the age of 65 is expected to live another 19 years to the age of 84 years old. A woman who turns 65 today, on average, can expect to live another 22 years to the age of 87 years old. It is also important to note that 25% of all 65 years olds will live past the age of 90, while 10% will live past 95. These dramatic life expectancy increases also apply to younger generations as medical advancement continues. However, this can create a more unique problem for younger generations, as it will become more difficult to plan a successful retirement and maintain a comfortable lifestyle without outliving income. Unfortunately, there is no way to create an exact estimate for longevity. Overestimating or underestimating one’s longevity may result in a person outliving their income or experiencing a lower quality of life unnecessarily, which is why a life expectancy analysis is crucial in the retirement planning process. 

Medical History and Family Medical History

When it comes to life expectancy analysis, perhaps the most critical consideration should be medical history and family medical history. To develop a more accurate life expectancy analysis, individuals should strive to answer the following question: 

– Have you ever been diagnosed with high blood pressure, and if so, are you on medication? 

– Have you ever had a heart attack or been diagnosed with heart disease? 

– Do you have high cholesterol, and are you on medication? 

– Has anyone in your immediate family ever had a stroke?

– Have you or anyone else in your family ever had cancer? 

– Are both your parents still alive, and if not, how did they die, and how old were they when they passed away? 

– Do you participate in a healthy lifestyle? Eating healthy, daily exercise, and low-stress levels? 

– Have you ever smoked? 

– Do either of your parents smoke? 

– How often do you consume alcohol, and if so, how many beverages do you consume a week?

– Do you always, sometimes, or never wear a seat belt.

After mortality tables have been reviewed, Arizona-native Kevin Canterbury says that individuals can then decide or not they would like to add or subtract years to their life expectancy based on their answers to the questions listed above. If, for example, someone answered that both of their parents died in the late 50s of natural causes, this would constitute lowering their life expectancy by a number of years. Often, parents’ age of death is generally considered an anchoring data point for most longevity estimates, except in the event of death by unnatural causes.