Things rarely go according to plan. For example, if the Detroit Red Wings are running a carefully orchestrated power play, but one player gets out of position, then the team must re-adjust the whole strategy. Sometimes improvisation is required, but we can still do that in a risk-controlled and optimal way for your financial plan.
Saving for retirement is a lofty goal, and something everybody should begin sooner rather than later. However, we understand that life events take place that often derail the plan. That’s ok. It’s normal. In fact, the rules of the game can allow individuals to pull from retirements early without substantial negative impact. There are goals like paying for a wedding, saving for a house, helping kids with their education costs that may be higher priorities at the time. Some of those goals are given the ‘OK’ by the IRS to dip into your retirement accounts!
The government stipulates that we must wait until age 59 ½ before withdrawing from retirement accounts without a penalty. That goes for 401(k)s, IRAs, and Roth IRAs.
Other accounts have different rules; a Health Savings Account dictates that an individual be 65 or older to use the money for non-health-related issues to avoid a 20% penalty. A 457(b) plan lets account holders withdraw for any reason after they leave their job with no penalty.
For retirement accounts, there is a 10% early withdrawal penalty for withdrawing from them early. This “additional tax”, as the IRS calls it, applies to the retirement accounts many of us have. The IRS, bless their heart, is trying to discourage us from using retirement funds for other purposes. But there are legal ways around it.
For young people, a common use of retirement money is to make a down payment on a house. The IRS allows IRA account holders to withdraw up to $10,000 for a qualified first-time home purchase. This does not apply to 401(k)s, however. Also for you youngsters out there, you can tap an IRA to help pay for education expenses (once again, not your 401(k) though).
If an individual becomes permanently disabled, then early withdrawals from both 401(k)s and IRAs are allowed with no penalty. Also, if you have medical expenses greater than 7.5% of your adjusted gross income (10% if under age 65), then you can avoid the 10% early withdrawal penalty on both a 401(k) and IRA.
Military personnel called to duty may tap retirement accounts without the worry of a penalty.
There’s a little trick out there. We probably shouldn’t even tell you about it. It’s called the 72t distribution or taking “substantially equal periodic payments”. There are some fine details (like anything related to retirement savings & the IRS). In this case, you must withdraw money from an IRA or employer-sponsored retirement plan according to a specific schedule. You can begin taking from your IRA at any time but must distribute money every year for at least five years until you hit age 59 ½.
An easier (and more common) approach is to simply withdraw from your Roth IRA up to the amount you have contributed. For example, if you have $10,000 of contributions, and the account is worth $15,000, then you can take out $10,000 tax-free, penalty-free for any reason. It’s actually one of the reasons why we encourage young folks to contribute to a Roth IRA early in their careers.
One more nuance that the IRS graces us with. If you leave your job between ages 55 and 59 ½, then you can withdraw from your 401(k) or 403 (b) plan without penalty. In essence, you can ‘retire’ a little early. Unfortunately, if you continue working, the only way to access your 401(k) is to take out a loan from the plan.
A 401(k) loan must be paid back to the borrower’s account under the plan. The money is not taxed if the loan meets the rules and the repayment schedule is followed. Not all employer-sponsored retirement plans allow for the loan provisions, however.
There are a lot of details that we don’t have time to tackle in this short piece. Take heart though, we cover all the bases when we strategize YOUR plan. General guidelines are great, but it takes more effort and know-how to develop the right power play to achieve your financial goals.
Here’s the point
- In general, you must wait until age 59 ½ to begin withdrawing from retirement accounts. Taking money from IRAs and 401(k)s early may result in a 10% penalty.
- There are common strategies to avoid the pesky 10% ‘extra tax’.
- 401(k)s and 403(b)s may feature a loan provision while Roth IRAs allow you to take your contributions out tax-free, penalty-free at any time.
- First-time home purchase and paying for education expenses are two common exceptions to the 10% early withdrawal rule.
Action items
- Do you need money from your retirement accounts? Talk with us first. Let TFC use our expertise to help you meet your goals.
- Don’t feel embarrassed or disappointed with yourself for withdrawing from a retirement account early – it’s very common. We can do it in a smart and tax-savvy way.
- Let us help you with other areas of your financial picture – if you are buying a house, let’s work together to ensure that fits your long-term plan well. If you are needing to pay for medical bills, let’s review your risk management & insurance situation. We are here to serve you!
Image by Nattanan Kanchanaprat from Pixabay.