Many academics are 403(b) rich. But they are poor in terms of their spendable assets, which limits estate planning and tax management options. It also makes retiring early difficult. Fortunately, an IRS 72(t) exception can help with early retirement.

Imagine that Professor Reddy Echols II is ready to retire from the mathematics department. Having proved the Riemann hypothesis, his life’s work in math is complete. Now at the young age of 40, he is ready to give up the responsibilities of the classroom.

Life planning is less about financial success and more about personal significance. Having achieved a well-paying tenured position relatively quickly, it may be difficult for teachers to contemplate changing careers. But if you focus on reaching your goals, your finances need only match what your goals require. Professor Echols now wants to spend time on other pursuits. So he either needs to seek a new patron or find a way to provide for himself in early retirement.

Retirement, traditionally the brief period between a career that lasted longer than life expectancy and death, is being redefined. In fact, when the Social Security program began, benefits started at age 65 and life expectancy was only 61. My father took his first retirement when I was 16 years old, and retirement is the only endeavor that has ever stumped him. At 81, he has just finished teaching his course on global finance at Stanford University.

The new definition of retirement is financial freedom: having the means to do whatever you want to do regardless of the remuneration. Having achieved financial success, you are now free to seek personal significance.

Many people find it challenging to reach financial independence by age 65. It does require planning, but it certainly is not impossible. If you save 15% of your standard of living starting at age 20, you should be able to retire comfortably at age 65 even if the market performs poorly. But unfortunately, most people don’t start saving at age 20, and few save at least 15% of their standard of living. Thus a majority of baby boomers are not on track to achieve financial independence at any reasonable retirement age.

Despite these statistics, however, retiring at age 40 is not a pipe dream. It simply requires more discipline. After adjusting for inflation and considering typical market rates of return on a balanced portfolio, for every dollar you save over 20 years you will be able to retire with a lifestyle equivalent to what you were saving. Start saving $1,000 a month, and in 20 years you can retire with the purchasing power of $1,000 a month today.

In his progression from brilliant PhD candidate to tenured professor in his 20s, young Echols never really left behind the frugal lifestyle of a graduate student. Continuing to live modestly, his salary increased without a parallel rise in his standard of living. Consequently, he started by saving $2,500 a month, or $30,000 every year. At a 10% rate of return, he now has $1.8 million at age 40 and rightly judges that his means should be sufficient for his wants.

You can retire at any age as long as you keep your wants modest compared with your total portfolio value. You must be able to support your standard of living until you reach 100, so the younger you are, the smaller the percentage of your portfolio you can withdraw each year. At age 40, you can safely withdraw about 3.38% of your portfolio’s value and still support your lifestyle until you reach age 100. At a 3.00% withdrawal rate, you can support your lifestyle indefinitely because your portfolio should be able to earn at least 3% over inflation.

Having saved $1.8 million, Echols can safely withdraw $5,000 a month, or $60,000 a year. His $5,000 monthly stipend should provide the same purchasing power of the first $2,500 monthly contribution he made 20 years ago. Saving and investing through the university’s 403(b) plan, Echols now has all $1.8 million in his retirement account waiting for him to turn 59.5 years old.

Taking money from your retirement account early normally results in a 10% penalty. Income tax always needs to be paid, but there are eight exceptions to the age 59.5 rule that allow for penalty-free withdrawals. You may be able to take money from a retirement account prematurely in any of these five situations: unreimbursed medical expenses, medical insurance if you are unemployed, disability, higher education expenses, and first-time home ownership. Additionally, if you have inherited a retirement account, you may be able to or even required to begin making withdrawals. And you may also withdraw money from a retirement account and roll it into another qualified plan.

The final way to make penalty-free early withdrawals is to make annuity distributions. Because all of these methods are available for traditional IRA accounts, the first step for Echols is to move his 403(b) into an IRA rollover account.

The annuity distribution method allows Echols to retire early by waiving the penalty on withdrawals at any age so long as they are substantially equal periodic payments that continue until age 59.5 or for at least five years, whichever comes later. Maximum payments must be calculated using one of the IRS-approved methods.

The first method is the life expectancy method. The IRS provides a table of divisors at every age for a single life expectancy or a joint life expectancy. The single life expectancy for a 40-year-old is 43.6 years. So Echols could withdraw $41,284 a year, or just 2.3% of his portfolio value–a very conservative number.

The life expectancy method is easy to calculate because it doesn’t really factor in any significant account growth or appreciations. Each year your account balance at the end of the previous year is divided by a slightly smaller divisor. Amounts start small, and with any reasonable rate of return, the odds are that the account balance will grow enough to outpace withdrawals. This method works well for taking small contributions but not truly to retire and take the maximum safe withdrawals.

The second method is amortization: You are allowed to assume a reasonable interest rate of return for earnings on your portfolio. The IRS has even ruled that “reasonable” includes anything less than 120% of the “Mid-Term Applicable Federal Rate” for either of the previous two months. Using the month of April, the maximum reasonable rate of return is 3.45%, and Echols’s annual withdrawal could be as high as $80,430.

Using the amortization method, Echols can justify any withdrawal less than $80,430 a year. Simply by lowering the reasonable rate of return from 3.45% to 1.81%, the withdrawal rate drops to $60,000 a year. Better yet, Echols can split his $1.8 million into two accounts. One account with $ 1,343,000 using 3.45% as a reasonable rate of return would justify withdrawals of $60,000 a year. The other account of $457,000 could simply continue to grow without withdrawals until he’s 59.5 years old.

The advantage of having two accounts is that the second one can start withdrawals on a separate timing schedule and be calculated at a later date.

You would think the IRS rules would be clear and easy to follow, but they are not. Several IRS rulings suggest you can recalculate these numbers annually. Alternatively, you may be able to adjust for inflation annually.

The easiest method for getting more money in a future year would simply be to continue to create a new account and start an additional amortization flowing.

If your goal is retiring early, it is best to have significant taxable investments. As an alternative, the amortization method allows you to begin some withdrawal flows, as illustrated for young Echols. Fortunately, he is a former mathematics professor.

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