Life happens. Circumstances will always arise where you may need access to a large amount of money quickly and many investors will look to tapping into their retirement savings account as the answer. There are some cases where this may be the right move, however, there are other cases where this would not be worth the risks. According to a recent study, more than half of investors from age 18 to 34 have already tapped into their tax-advantaged retirement account. Before making a decision; you should schedule a meeting with your financial advisor since they may have a better option for you.
IRAs and 401(k)s are regulated by the federal government, which means they make the rules. The government does allow these retirement accounts to have deferred tax treatments with the stipulation that you will not take any distributions from the account until age 59 ½. Your financial advisor will be able to determine if the risks of dipping into your retirement accounts early are worth it. Sage Investment Advisors, LLC, located in Poughkeepsie, NY, meets with clients to review their circumstances to determine if taking premature distributions will make sense for them since they will be subject to an extra 10% early withdrawal.
So, what are the exceptions to the 10% early distribution tax? Navigating these rules may help you avoid substantial additional taxation.2
IRA and 401(k) Early Distribution Penalty Exemptions
The following are considered qualifying exemptions to the 10% early distribution penalty:
- Age. Withdrawals after the age of 59 ½.
- Death. It may be unfortunate to think about, but any withdrawals after the death of the account holder are not subject to penalty.
- Disability. Total and permanent disability of the account owner.
- “Substantially Equal Periodic Payments.” Under Rule 72(t), setting up substantially equal periodic payments for your life expectancy (or your designated beneficiary).3
- IRS Levy. Do you owe the IRS money? You may be able to cover unpaid taxes using a penalty-free withdrawal.
- Medical. This includes unreimbursed medical expenses in excess of 10% of your adjusted gross income (AGI).
- Military. Qualifying distributions to military reservists during active duty.
- Rollovers. Must be properly executed within 60 days.
- Natural Disaster. Some natural disasters receive temporary, event-specific legislation allowing penalty-free withdrawals on a case-by-case basis.4
IRA Early Distribution Penalty Exemptions
- Education. These include tuition, books, supplies, and other qualified education expenses for you, your spouse, children, and even grandchildren.
- First-time homebuyers may withdraw up to $10,000 without penalty.
- Health insurance premiums incurred during a period of unemployment.
401(k) Early Distribution Penalty Exemptions
- Separation from Service. If separated from service after age 55 (age 50 for certain qualifying governmental public safety employees).
- Loans. If allowed by the plan, you may qualify for a 401(k) loan. It is not a withdrawal, but the account is treated as collateral.
Do It the Right Way!
Documentation is important. Make sure you’re saving records and talking to the right people, such as your office human resources department and your financial professional. Hardship withdrawals may require proof once it’s time to pay taxes. It’s important to also keep in mind that any dollar taken out is a dollar that won’t grow or be available for your future retirement.
If you do find yourself having to dip into your retirement account, do not panic. Depending on your unique situation, you may have more time than you believe to pay your retirement account back. This is another reason why you should work with an experienced financial advisor who will develop a repayment plan to ensure the money taken out of your retirement account will be replaced.
If you are struggling to decide whether taking an early withdrawal from your retirement account is worth the risks, a professional financial advisor will be able to take a look at your situation to help you determine if this is an advisable strategy or if there is another, more viable option.
Published by Sage Investment Advisers, LLC in Poughkeepsie, NY
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.