For Mark Roberts’ Use: The point of your retirement account, whether you have an IRA or an employer-sponsored plan, is to help you save for your retirement years. Most of these plans offer important tax-deferred benefits, so that you don’t pay income taxes on the money until you begin taking withdrawals after age 59 ½. This allows you to prepare for retirement, while also providing valuable tax savings.
However, sometimes we all experience emergencies in life, and it can be tempting to withdraw funds from your retirement account. Before you do so, it’s important to remember that the IRS will want some of “their” money back if you bend the rules by taking an early distribution. All distributions tax-deferred retirement plans are subject to federal income taxes during the year in which you take them, but a withdrawal before age 59 ½ can also trigger an extra 10 percent penalty from the IRS.
Of course, the law does provide for certain exceptions to these rules. For IRAs, account owners can take an early withdrawal, free of the extra 10 percent penalty, in the event of:
- death of the account owner (technically, this means your beneficiaries would be taking the withdrawal)
- certain types of disability
- to cover unreimbursed medical expenses, subject to certain rules
- to pay for medical insurance if you lose your job
- as part of substantially equal periodic payment plan (SEPP)
- to aid in the purchase of a new home – but you can only use this exception once, and it’s subject to a $10,000 limit
- to cover higher education expenses for yourself or a dependent
For an employer-sponsored retirement plan, the exceptions are as follows:
- part of a SEPP plan
- separation from your employer
- you’ve separated from your employer and reached age 55
- part of a qualified domestic relations order (QRDO)
- medical expenses
- to reduce excess contributions
- to reduce excess elective deferrals
Even if your situation qualifies you for an exception to the rule, it still might not be a good idea to take an early distribution from your retirement plan. There are more costs associated with this course of action than the tax ramifications. Remember that while you might be able to replace the capital you borrowed from yourself at a later date, you cannot replace time. And since your retirement plans depend partly upon compounding interest over time, that is money you might never earn back.
When possible, avoid taking early withdrawals from your retirement plan, and find another way to cover emergency expenses. Remember that we are happy to receive your questions, schedule an appointment, and talk with you about your financial planning strategy. Often there is a better way to fund life’s little expenses, without placing your retirement fund at risk.