Usually, we’d never recommend withdrawing savings from your retirement funds until you come of age. But, in certain circumstances, it makes sense to access your money early. Traditionally, the IRS will allow you to withdraw funds after you turn 59½ years of age. However, accessing money prior to this will land you with a 10% tax penalty – though not in all circumstances. Here are 3 situations in which it makes sense to withdraw your retirement funds early.
1. If You Are Dealing with a Serious Illness
If you’re very ill or have a terminal illness, it makes no sense to save your retirement funds for ‘someday’, your time is now, and you’ll likely need to spend your savings on medical care instead. For those under 65, the IRS will waive the penalty on money used to pay your medical bills, as long as they exceed 10% of your adjusted gross income. This exemption applies to money withdrawn from a 401(k) plan or an IRA. The same applies if you become permanently disabled.
2. If You Are Facing Financial Oblivion
Lost your job? Facing bankruptcy? If so, your retirement savings should be considered fair game. Why keep those funds locked up if you can’t afford to live in the present?
If financial distress is causing a huge disruption to your life, your retirement fund might not be taxed upon withdrawal, but you’ll still face the 10% penalty. Just make sure the trustee of your plan withholds the 10%, that way you’ll be covered at the time of filing your income taxes.
3. If You Can Avoid the 10% Early Withdrawal Penalty
There are also a few other situations where you can withdraw from your retirement account early and still be able to avoid the 10% penalty. This option is available if you earn less than you did at the time of contribution, as your income tax bracket will now be lower.
Withdrawal of contributions from a Roth IRA: With a Roth IRA, you can take out your savings at any time because you have already paid tax on the money. However, any earnings your money has made from interest or investments will be subject to both income tax and the 10% penalty if you are younger than 59½.
Substantially Equal Periodic Payments programs, or SEPPs: A SEPP program is another way that you can withdraw funds early. You can take from either an IRA or 401(k) before turning 59½, and still avoid the 10% penalty. There are 3 different ways to calculate a withdrawal:
- the Required Minimum Distribution method,
- Amortization method and,
- Annuitization method
To see more about SEPPS, check the IRS website to get all the information you need.
Separation from Service by age 55 or older: If you become unemployed for any reason after turning 55 you can withdraw funds from a 401(k) plan without being subject to the 10% penalty. However, SEPPs don’t apply to IRA accounts, so you might want to consider this before rolling over any previous employer plans.