What you should know about withdrawing retirement funds early

Retire

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Is your retirement money only for retirement? Ideally, yes. But it’s your money, so the decision of what to do with is ultimately yours. During financially challenging times, it’s easy to understand the temptation to tap into retirement funds earlier than planned. But here’s what you should know before you consider accessing retirement savings early.

Taking money out of a retirement account may have financial penalties.

There are different rules on early withdrawals depending on the type of account. The type of account you want to take money out of will determine the penalties.

401(k)

You maybe able to withdraw funds from your 401(k) via a loan or hardship withdrawal, but there may be plan limitations on these withdrawals. Note loans must be repaid, and hardship withdrawals are subject to a 10% penalty and income tax. If you have a 401(k) plan from a previous employer you may be able to access that savings with less restrictions – but early withdrawals before age 59 1/2 are subject to the same 10% penalty and income taxes.

Traditional IRA

Traditional IRAs are subject to similar penalties and taxes on distributions as the 401(k) is, but the exceptions are a little more relaxed. For example, first time home buyers can take out $10,000 from their Traditional IRA without paying the 10% fees. You do still need to pay income tax on this withdrawal though. The same applies for qualified education expenses and health insurance premiums while unemployed—you won’t pay the 10% fee, but you will pay income taxes.

Roth IRA

Since Roth IRA contributions are post-tax, the rules are not the same as the pre-tax accounts. You can withdraw your contributions from a Roth prior to age 59 ½ without a penalty or tax, but earnings would usually still be subject to tax and 10% penalty. As an example, if you have $12,000 in your Roth and you contributed $10,000 and earned $2,000, you can take out your $10,000 with no penalties or taxes. If you wanted to take out your $2,000, however, that money would likely be taxed as income and you would pay the 10% penalty. In addition, your initial contributions must have been made at least 5 years ago before withdrawing earnings penalty-free.

However, there are some exceptions to these penalties.

If you withdraw money early for the following reasons, you are exempt from paying the 10% early withdrawal fee on the money for your 401(k) or your IRA:

Total disability of the account holder
IRS levy
Death of the account holder

You can read about all of the exemptions here. Some situations exempt certain accounts, but not all accounts.

If you experience a financial catastrophe like disability or a legal problem, you should seek a professional’s help to see what options are available to you.

Consider early withdrawals carefully.

You wouldn’t be the first person who wanted access to their retirement funds early. After all, it’s easy to see a chunk of money in your retirement accounts and think of all the ways it could come in handy right now. However, taking early withdrawals if you don’t fall into an exempt class can mean that you lose a lot of your money to fees and taxes. Plus, it puts the original goal of your savings – your retirement plans – into jeopardy.

If you do ultimately decide to take the money out early, it’s a good idea to plan how and when you will replace the funds.

The content of this document is for general information only. It is not intended to provide investment, tax, or legal advice. Please consult your own independent advisor as to any investment, tax, or legal statements made herein.

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