Does It Ever Make Sense to take the 10% Early Withdrawal Penalty?

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Last Monday’s Reader Case sparked some discussion over whether it makes sense to take the 10% early withdrawal penalty that comes from making a 401(k)/Traditional IRA withdrawal before the age of 59.5 instead of doing the Roth Conversion Ladder.


Well, the counter argument referred to this very thorough and informative post from the MadFientist, who did a comparison of 5 ways of accessing your retirement funds.

In that post, he claimed that in certain situations, deliberately taking the 10% Early Withdrawal Penalty actually beats the Roth Conversion Ladder strategy, which seems completely bonkers and counter-intuitive to me.

So I was at a bit of a dilemma. MadFientist is a fellow Chautauqua speaker, deeply respected in the FI community, and a good friend of mine. Should I just blindly trust my friend, or should I go where the math takes me at the risk of disagreeing with him?

In the end, I decided, as I always do, to MATH SHIT UP and damn the consequences. MadFientist and I can always make up later over his favourite craft beer.

Ready? Here we go!

Now, the biggest, most important conclusion from MadFientist’s post is that putting money into your tax deferred accounts always makes sense regardless of how you later withdraw it. I whole-heartedly agree with that. And, as an added plus, if there’s any employer-based matching program for your 401(k) contributions, it becomes even more of a no-brainer. Free money AND it’s taxed deferred? Yes please!

So that’s all fine and good, but he also claims that in specific cases, withdrawing early and taking the 10% penalty actually beats using the Roth Conversion Ladder. Really? What is this sorcery?


First of all, for the typical early retiree that leaves their job and never works again: No. Unquestionably no.

The draw-down strategy outlined by many FI bloggers including ourselves and in our book, is operating under the assumption that after you retire, you never earn a cent again. In that scenario, an early retiree can convert their 401(k)/Traditional IRA into their Roth IRA gradually each year, being careful to make sure their conversions are equal to their Standard Deduction.

In this situation, they are able to get money out of their 401(k)/Traditional IRA at a tax rate of 0%. You can’t get much better than 0%, so in this case, definitely do that shit. Build your Roth Conversion ladder, convert at 0%, wait 5 years, then withdraw tax-free.


So that being said, why would MadFientist ever claim that it was a good idea to deliberately take a 10% penalty?

Because, it appears, he’s assuming that our early retiree has used up their Standard Deduction and is now being taxed at a marginal tax rate.

This is evident in a lot of his math, as he states that in his test case, his subject is taxed at a 15% marginal rate. This is not a retiree who is sitting around doing nothing, but rather a retiree who has decided to start a bit of a side hustle and has earned enough money to eat up their Standard Deduction.

This is also, as it turns out, the situation that last week’s reader case plans to be in.

So MadFientist is not wrong. At all. Rather, he’s actually surprisingly relevant to our reader case!

But I’m still suspicious of his claims that it EVER makes sense to voluntarily take the 10% penalty. But rather than sit around and speculate, let’s see where the math takes us, shall we?

To understand this phenomenon, let’s look at 3 scenarios:

Scenario 1: Roth Conversion Ladder

Assume we have a retiree who’s quitting at 40 years old. She has a $100,000 portfolio, is making $12K/year in side-income, and she plans to withdraw $10K each year.

Normally, your income drops to 0 in retirement, so you’ll be able to convert your Traditional IRA to a Roth tax free because you can shelter $12K/person within your standard deduction.

But in this case since this retiree’s side income is taking up her standard deduction room, she won’t be able to do the Roth Conversion ladder tax free (Wahh. First world problems, I know).

So if she were to convert 10K/year from her IRA, her taxable income would be $22k. I put this into a tax calculator, and it spit out that she would owe $1010 in taxes.

Over 5 years of implementing the ladder, she’ll have paid $1010 x 5 = $5050 in taxes. We’ll also have to factor in the investment gains they’ve forgone because this money went to the government instead of stayed in their IRA.

That means her portfolio at the end of the 5 years and using a conservative 6% return rate, her portfolio looks like this:


Scenario 2: Withdraw with Penalty

But what if she didn’t build the IRA ladder? What if she immediately withdraws the money right at 40 when she quit her job? She would be paying the same taxes: $1010/year plus a 10% penalty on the 10K she withdraws.

After 5 years, this is what her portfolio would look like:

Since she had to pay the extra 10% each year and she’s missing out on the returns earned on this money, this portfolio is $5975.32 less than if she had built the conversion ladder in scenario 1.

Scenario 3: Wait 5 years, then Withdraw

But, what if she were to wait 5 years letting the money compound tax-free before withdrawing it with a 10% penalty like the scenario in MadFientist’s post?

Wowee, right? This strategy seems to take the cake! Of course you would to this, right? Look how much up-and-to-the-right that grey line is compared to the rest of them!

Not so fast.

Because this is only a snapshot in time. This doesn’t show the whole picture because it’s in year 6 that she would start getting hit with the 10% penalty every time she withdraws, and those penalties keep hitting her forever. Let’s see what this does to her withdrawals over time.

Boom goes the dynamite. While the moment at the 5-year mark might make the Wait-and-Withdraw method seem like it wins, over the long term the continuous drag of the 10% early withdrawal penalty takes its toll. As we zoom out to a 30 year retirement, this drag overtakes these gains.

And of course Scenario 2 comes in dead last, because obviously if you withdraw right away, you get hit with the taxes AND the penalty. No bueno, so don’t do it.


Now, that’s all well and good, but I was curious and thought, “does this effect change depending on the tax bracket?” So that’s what I tested.

By sweeping the tax rates, I found something rather interesting: a situation where it DOES make sense to voluntarily pay the 10% penalty.

Here’s the two strategies of the Ladder vs. Wait-and-Withdraw charted out on a 10% tax rate.

Now here it is again at the next federal tax bracket, 12%.

See that? Where the Roth Conversion line dips lower and takes longer to come up and overtake the Wait-and-Withdraw line? That’s because the added effect of taxes reduces the amount of money available early on. And because there’s less money up front, there’s less to compound. And because there’s less to compound, there’s less to compound. And so on.

At 24% tax bracket:

At 32% tax bracket:


When you retire and earn money in a low tax bracket like 10% or 12%, even though it seems like Wait-and-Withdraw is beating the Ladder at the beginning, Ladder comes roaring back in the long run as all those 10% penalties add up over the years.

BUT if your side hustle is SO successful that you end up in a high tax bracket (>24%) right from the get-go, then Wait-and-Withdraw actually WINS. The effect of your portfolio being hammered by high taxes early on has such a negative effect on the long-term compounded gains that Ladder NEVER catches up to Wait-and-Withdraw. So in this case, it actually does make sense to delay your withdrawals and instead voluntarily pay the early withdrawal penalty.

Math Shit Up, yo!


So whether it makes sense to use a Ladder or Wait-and-Withdraw with the penalty is dependent on two factors: Your age and your marginal tax bracket at retirement.

For most people reading this blog, the correct answer is to use the Ladder. This is because the typical early retiree (if there is such a thing) will have a lower tax bracket at retirement and have such a long retirement timeframe that the Ladder strategy will eventually overtake the short term bump that Wait-and-Withdraw gives you.

But there are two specific groups of retirees that shouldn’t bother with the ladder.

The first is older retirees. If you’re in your 50’s, don’t bother with a Roth IRA ladder. You won’t have that long until you hit 59 1/2 and by then the penalties go away anyway.

The second is early retirees with ridiculously successful side hustles. If after you retire, your side hustles push you into a high enough tax bracket ( >24%), you’ll end up paying way too much tax during the first 5 years and in that specific case, it makes more sense to wait 5 years, then start withdrawing and paying the 10% penalty over time. That being said, making too much money in retirement doing what you love is the definition of champagne problems, so I wouldn’t cry too much over these poor souls.

What do you think? Are you going to use the Roth Conversion Ladder or just withdraw and take the 10% Penalty?

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27 thoughts on “Does It Ever Make Sense to take the 10% Early Withdrawal Penalty?”

  1. Nice.
    See if you can help me here PLEASE PLEASE PLEASE – I’m in the 32% US tax bracket now and I’m moving back to my home country next year. Should I pay the 10%+tax now and take my money with me or leave it here until I’m 59/2 keeping in mind that my home country WILL tax anything I take out of 401(k) at 30% no matter what or when? Could you math this shit up for me Kristen?

    1. Just curious – what country are you moving back to? It seems odd that a foreign country would tax an IRA/401k distribution. I guess it all depends on the country and tax treaties with the US. It could also depend on timing and how much money you are moving. For example, if the 401k has a small balance (or more accurately has a small amount of taxable gains) and you withdraw in January, you might not be in the 32% tax bracket. Given however that you are in the 32% bracket right now, I’d guess you probably have a nice amount of taxable gains in your 401k.

      I have made a couple of international moves and had to deal with various savings accounts in each country. I’d definitely spend a few hundred bucks on a tax consultant to make sure you do this right.

      1. That’s exactly the problem. My country (Brazil) doesn’t have any tax treaty with the US. I have about 240k in it (about 25% is gains). I always did my taxes myself on TT.

        1. Hi Renato, I agree with Dave. It’s a good idea to get an accountant who specializes in Brazilian and US taxes to look over your financial situation. Since I’ve never lived in Brazil myself, I’m not familiar with the taxation laws there.

  2. Going to wait and take the penalty
    I will have rental income
    And retiring at 45 so will only withdraw as needed
    I will use my 401k as a super emergency fund
    Also don’t forget about the 72t
    One may not want to set one up at 35-40 but after 10yrs of early retirement you should have a good idea of expenses and at that point setting one up may work out well.

    1. Thanks for sharing, Brian. And 72t/SEPP is one of the methods the MadFientist article compared, which I’ve linked to above. To keep it simple I focused on the penalty and the ladder scenarios since they are more pertinent to the reader case.

  3. “That being said, making too much money in retirement doing what you love is the definition of champagne problems, so I wouldn’t cry too much over these poor souls.” Haha amen! Now that is the dream!

    And PUMPEDDD to finally be able to watch Playing With Fire in Canada!

      1. It was goooood! You got so much airtime girl!!! ? I just wish it was 20 mins longer to touch on more of the FI concepts (besides happiness) – I guess more so of how the numbers work, what savings rate means, etc and different ways to get there besides up and moving as that’s not always necessary. That’s not to dismiss how awesome of a film it is – def recommending it TO ALL!!!

  4. So what if I have a pension that pays 43k a yr and I have 400k saved in my 457 which I can take out penalty free when I retire next yr in 2020? I am 51 and will be taxed on my pension and 4% drawdowns in the State of Virginia. I was thinking the Roth conversions will help me in my later yrs. Your thoughts would be welcomed and appreciated.

  5. So what if I have a pension that pays 43k a yr and I have 400k saved in my 457 which I can take out penalty free when I retire next yr in 2020? I am 51 and will be taxed on my pension and 4% drawdowns in the State of Virginia. I was thinking the Roth conversions will help me in my later yrs. Your thoughts would be welcomed and appreciated.

    1. Tammy – my situation is very similar to yours in age and pension benefit but less in my 457b. I also have a 401k, Roth IRA, inherited IRA (Roth and traditional), and an after-tax brokerage account.

      I rent but have zero debt and am seriously considering retiring in Aug 2020 to travel about 8 months out of the year to low-cost places in SE Asia and Eastern Europe.

      Will you need the entire $4ook (in the 457) to hold you over until you can tap IRAs and 401k at the 59.5 years old and SS at 62 years old? If so, then you wouldn’t want to do the Roth conversion because you would lose access to the funds when they are first converted into a traditional IRA.

      Most likely you will be in a lower tax bracket after retirement and having the 457 available for 8+ years is critical. What are your thoughts on this?

      1. Hi Drater,

        I also have a Roth IRA with 30K and a 401a with 30k and just opened up a Charles Schwab brokerage account for my side hustle I’m going to have (house hack/rental).

        I do own my townhouse and am starting to house hack it and will eventually rent the whole townhouse. Even before I put a renter in here, my pension will pay for all my needs. I plan to purchase a smaller 1 level condo but will make sure the pension pays for everything.

        I will also have a part-time job and will eventually decide if I even need that if my rentals bring in enough cashflow. I only picked up a part time gig, to keep my mind busy. I do plan to travel a bit.

        I will draw down on my 457 right away but I don’t even think I’ll need the 4% since house hack and part time gig. My pension will pay all essentials and the other stuff will all be fluff. I guess I can just stack all new income into the Vanguard Roth. I was just going to move the standard deduction of 12K over to the Roth each year from my 457 but now I’m wondering if I even need to or will it benefit me at all. I feel like having quite a bit of money to use tax free will always be something to strive for to use for the future. I can’t access the 401a until 59.5 but I won’t really need it anyway. Once SS kicks in, my income will increase.

        So will it always just be a tax suck and plan on keeping it there in the 457 and draw down as needed? Or plan on the tax suck for one day having access to tax free money in the future from the ROTH?

        I estimated with a FIRECALC that with a 4% drawdown, I will never run out of money and it will increase faster than I could spend at that rate so I was planning on increasing my drawdown percentage to live large as each year went by.

        My adult son is learning from me and is planning for his own smart FIRE future. He is not expecting a cash benefit upon my death. LOL. I have no spouse so I’m good. My girlfriend also has her own pension for life from a previous divorce to a military person.

        At some point I def want to travel abroad and live a few months here and there as you mentioned. Anyway, any insight would help and I appreciate you sharing your story with me.

    2. Since your pension puts you in a higher tax bracket (22%) and your age is only 8.5 years from the 59.5 threshold, there’s no need to use the Roth conversion ladder.

  6. I’m surprised no one has mentioned Substantially Equal Periodic Payments (SEPPs – This allows you to take distributions from a 401k or IRA without the 10% penalty. The catch is that the IRS makes you choose between a couple of formulas to calculate the distribution amount, and then you have to keep taking the distribution until you reach retirement age. I don’t know how this would compare to doing the Roth conversion, but it seems way better than paying a penalty!

    1. Hey Brian, the article from Madfientist I linked to in the post includes SEPPs in his comparison. I didn’t want to get into it in this post to keep things simple, but based on his analysis, SEPP wins. The biggest caveat is that you have take out the exact same distribution each year, even if you don’t need it. I think this makes it difficult because as we’ve seen, many FIRE people end up making unexpected income on passion projects in retirement, so that consistent distribution assumption goes out the window.

      1. Oh, thanks for the reminder! It’s been a while since I read MadFientist’s post. Personally, I’m going with the Roth conversion approach, since I’m haven’t got much else using up my standard deduction, and I too appreciate the flexibility that you’d lose from SEPPs.

  7. Nothing wrong with double checking the math! I always like working out calculations myself rather than taking someone else’s word for it. SO forgive me if I’m wrong, but I think this post is misleading.

    If you are in the same tax bracket at the beginning and end of retirement, it doesn’t matter when you pay taxes on it because you will end up with the same amount of after tax dollars. $100,000 conversion taxed at 32% will be $68,000. After 10 years and 6% returns, it will be $121,778. If you decide to leave the $100,000 in your traditional/401k for 10 years, you’ll have $179,085. Sure it’s technially more money than what you would have had in your Roth, but after 32% taxes, you end up with the same amount $121,778. If you are in the same tax bracket, it does not matter if you pay taxes on it up front, at the end, or periodically with Roth conversions… your money grows at the same rate and your after tax dollars remains the same. However, taking a 10% penalty WILL have an effect on your after tax wealth. This is where I am having trouble understanding why someone in a higher tax bracket (or anyone) would benefit from the 10% penalty.

    In Mad Fientist’s example, the retiree is choosing between saving in a taxable brokerage account vs a tax-deferred account. He showed that it is more advantageous to contribute to tax-deferred accounts and take the 10% penalty for early withdrawl rather than saving in a taxable account. However, the retiree in your example is no longer saving for retirement. She should take the 10% penalty only if she needs the money right away. If she is able to wait 5 years, then she should use the roth conversion ladder for withdrawals. Your after tax wealth grows at the same rather whether it’s in your Roth IRA or Traditional IRA/401k. There is no benefit to waiting 5 years and taking the 10% penalty because it will eat into your after tax wealth.

  8. I assume your comment: “If you’re in your 50’s, don’t bother with a Roth IRA ladder. You won’t have that long until you hit 59 1/2 and by then the penalties go away anyway.”-was just in reference to this example —not related to RMDs.—a whole other ball of wax.

  9. Hi FIRECracker,

    I just wanted to thank you for this commonsense breakdown. What a confusing topic!

    Keep up the good work, the world needs more people like you!


  10. I’m totally speculating on this one….

    …As we all know, healthcare in the US is a total catastrophe. Assuming the early retiree is adamant about not working and also doesn’t generate sufficient passive income to meet the ACA(obamacare) threshold, then the only government based healthcare program they might be able to access is Medicaid, which totally sucks. This is the program for people in poverty, very limited access to providers. You definitely don’t want to be in this program (I’m not sure that Medicaid would even be available. ACA eligibility is income based, but Medicaid might be income AND asset based, which would disqualify most FIRE people).

    I’m wondering if it might make sense to do a yearly conversion above the Standard Deduction as a mean of artificially increasing ones AGI, thus making them qualified for ACA healthcare. Maybe just enough conversion where they start to tickle the minimum ACA income requirement such that a “Silver Plan” is heavily subsidized and costing maybe $25/month or so.

    …I’m pulling these numbers out of my ass, but hypothetical, if a person does a $20K conversion in a given year, maybe the tax hit is a couple thousand dollars. If the resultant AGI places the person in a position where their ACA plan is heavily subsidized, it could conceivably be worthwhile doing the conversion. In this hypothetical scenario, the person would effectively be paying less than $200/mo for healthcare, which is pretty damn good in the US.

  11. So, I bought Playing With FIRE on iTunes, watched 5 minutes of it and promptly requested a refund.

    Because i don’t want to watch it on my iPad, and apple won’t let me cast it to my TV using chromecast.

    Bought it on Vimeo instead. iTunes sucks balls. Great movie.

  12. I’ve lost 40% of my IRA in the last year. Aren’t I better off withdrawing what’s left at a 10% penalty? I only see things getting worse in the next 2 yrs. I’m 59 in 4 yrs. I am not working.

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