Last week, we talked about the pros and cons of borrowing from your retirement savings. You may recall that there were more cons than pros! Now, as promised, here’s a breakdown of your penalty-free withdrawal options if you really must dip into your retirement savings as a last resort.
Avoiding the 10% early withdrawal penalty
There are a few situations in which you can withdraw from your tax-advantaged retirement account without the 10% early (before age 59 ½) withdrawal penalty. These rules do not apply to a Roth IRA because those funds are taxed prior to contribution and may be withdrawn (also known as a distribution) without penalty or additional tax after five years.
Keep in mind that penalty-free doesn’t necessarily mean tax-free. All withdrawals are still subject to regular income tax. Unless specifically stated, these rules, including hardship withdrawals, do not necessarily apply to your 401(k) plan; you’ll need to check with your employer to be sure.
Penalty-free withdrawals may be allowed for:
Qualified higher education expenses: You are able to withdraw from your IRA for qualified education expenses like tuition, books, and other supplies for either you, your spouse, children, or grandchildren. The distribution would be taxed at your ordinary income tax rate, but there would be no penalty.
First-time home purchase: You can also distribute (withdraw) up to $10,000 over your lifetime from your IRA for a first-time home purchase for either yourself, spouse, children, or grandchildren. If you have not owned a home in the prior two years, a home purchase is considered “first-time.” The distribution would be taxed at your ordinary income tax rate, but there would be no penalty.
Income purposes: One exception to the tax penalty rule, called section 72(t), allows you to withdraw from your tax-advantaged retirement account to provide income to yourself. You must take “substantially equal periodic payments” over time. The shortest amount of time that payments can be distributed is five years, so potentially you could take one payment yearly for five years or until the age of 59 ½.
Medical expenses: The government allows you to withdraw from your tax-advantaged IRA if you have incurred unreimbursed medical expenses that are greater than 10% of your adjusted gross income (your pre-tax income minus specific deductions).
Death or disability: If you are considered to be disabled by an insurance company or Social Security, you are able to withdraw from either your 401(k) or IRA account penalty-free. In the case of your death, your beneficiaries are able to withdraw funds without penalty.
Financial hardship: The IRS defines a financial hardship as not being able to meet allowable living expenses (e.g., providing food for yourself, paying your mortgage, or maintaining utilities). In this case, you are able to withdraw from your tax-advantaged 401(k) plan (after consulting your employer) or IRA by filing the necessary forms.
Money set aside into both a MoneyLion investment account (learn more: online |mobile) as well as a retirement savings account can grow much bigger over time and benefit you more if left untouched. Unless there is a true emergency, use the money for what it was meant for, your future.