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Taking an Early Withdrawal on IRA or 401k

Thomas M. Geier, CPA, CFP®, PFS

When an emergency happens and money is needed to pay the unexpected expenses that go along with it, some people look to their retirement savings as a necessary source of funds. And, in fact, you can take distributions from your retirement accounts at any time. In fact, there is no need to show any hardship. However, here are some factors to consider.

Factors to Consider Before Withdrawing Early

First, the amount of the distribution from your IRA or 401(k) will be included in your taxable income (except for Roth distributions that have met the 5 year holding period). So, think about the impact on your tax return, and if withholding on the distributions should be considered.

Next, if you take a distribution before age 59 and a half, an additional ten percent penalty will be applied. IRA’s and 401(k)’s are meant to be long term savings vehicles, and the penalty was meant to discourage removing funds until close to retirement age.

Can I Avoid a Tax Penalty?

However, you may be able to take a distribution before age 59 1/2 without paying the 10% penalty if you meet one of the hardship exemptions listed below.

  1. You are taking the distribution as the beneficiary of a deceased IRA owner. Generally, if you inherit an IRA, you are required to take required minimum distributions (RMDs) over a period no longer than your life expectancy. For non-spousal beneficiaries, RMDs must begin in the year following the year in which the IRA owner died. Spousal beneficiaries may have additional time to begin taking RMDs, depending on certain factors, including whether they opt to treat an inherited IRA as their own. This penalty tax exception does not apply to spousal beneficiaries who opt to treat the account as their own IRA.
  2. You are paying for certain first-time homebuyer expenses, generally referred to as qualified acquisition costs, such as buying, building, or renovating a first home. Distributions, which may not exceed $10,000, may be used to cover qualified costs for you, your spouse, your children, or your grandchildren.
  3. You, your spouse, or dependents have unreimbursed medical expenses that total more than 10% of your adjusted gross income. If a medical expense for you, your spouse, or a dependent qualifies as an itemized deduction on your income tax return, it will generally qualify for this penalty tax exception.
  4. The distributions are part of a series of substantially equal periodic payments (SEPPs).
  5. You qualify with certain physical and/or mental conditions as being disabled and the disability can be expected to result in death or continue for an indefinite duration.
  6. You need to pay medical insurance premiums due to unemployment. If you lost your job, and received unemployment compensation for 12 consecutive weeks, you may take distributions from your IRA account, penalty tax free, during the year in which you received unemployment compensation, or in the following year, but no later than 60 days after you have been re-employed.
  7. You need to pay for higher education expenses, such as tuition, fees, and books at an eligible educational institution (generally all accredited postsecondary institutions). The distributions may not exceed your qualified education expenses, or those of your spouse, your children, or your grandchildren.
  8. The distribution is the result of an IRS levy on the IRA.
  9. Reservists can qualify while serving on active duty for at least 180 days. IRAs are strictly regulated to ensure that they are used as vehicles for retirement savings. Therefore, they generally work best as long-term savings vehicles.

Some 401(k) plans allow loans to be taken out of the plan. Check with your employer to see if this option is available.

Feel free to call us to discuss any possible ramifications to pre-retirement distributions. At Geier Asset Management, we do our best to provide all needed information to help you make the best decision.

 

© Geier Asset Management, Inc.  Jan 2018. Thomas M. Geier is a Vice President of Geier Asset Management, Inc., a Registered Investment Advisor. The above blog reflects the opinions of Mr. Geier and not necessarily the firm. Any advice given is general in nature and investors must consider their own individual circumstances. Past performance is no indicator of future performance. The firm makes no warranties or representations of any kind relating to the accuracy or timeliness of the information provided.