The longer you live, the more situations you will encounter where cash would certainly come in handy. Whether you face significant medical expenses, incur debt in an upside-down mortgage, or simply could use more liquidity in terms of assets to help yourself or your family, you may be contemplating what would formerly have been unthinkable: touching the retirement fund prior to your “official” retirement age. You are certainly free to use your assets in the way that seems best — it is, after all, your money — but be sure you weigh all the potential ramifications of such withdrawals, both short and long-term.
Early Withdrawals = Real Cash Lost
The amount by which you are penalized depends on several factors and the most important is your age. If you withdraw funds prior to age 59½, you incur both a reduction in total funding available and an early distribution tax. The amounts differ depending on whether your money is in Traditional or Simple IRAs, whether your state imposes taxes on these early withdrawals in addition to the federal penalties, and whether you qualify for any exceptions to the early-distribution rules.
With no exceptions in place, you can expect some “hits” on your retirement income’s bottom line. Prior to age 59½:
- You will be liable for both federal income tax and a 10% early distribution tax on any previously untaxed funds in Traditional IRAs or other qualified retirement funds.
- You will need to absorb a 25% additional early distribution tax instead of 10% on a Simple IRA, within two years from the first day the funds are deposited.
These penalties also apply to 401(k) plans, 403(b) tax-sheltered annuity plans, and any plans you have set up as a self-employed worker. In other words, be prepared to “pay the piper” for a pre-retirement quick infusion of cash.
There Is Also Good News
Even if you are “too young” for your retirement money to come to you otherwise unencumbered, you can escape many penalties if you withdraw the funds for one of several specific purposes:
- Qualified college costs for yourself, your spouse, children, or grandchildren.
- Unreimbursed medical expenses that add up to more than 7.5% of your adjusted gross income — in other words, expenses that are deductible on Schedule A. You can take this exception even if you do not normally itemize.
- Medical insurance for you if you are unemployed. The amount you pay for medical insurance for yourself, your spouse, and your dependents can be exempt from penalty if you have received unemployment compensation for at least 12 weeks.
- Purchase of a first home — for which you can exempt up to $10,000.
- Costs associated with a total disability. The exception depends on your furnishing proof, certified by a physician, that you cannot perform substantial gainful employment.
- Rollover into another qualified retirement account (such as a Roth IRA) within 60 days. (Of course, this does not release the cash to you, but it does eliminate a potential penalty.)
You Can Even Change Your Mind… With a Few Conditions
One thing you may not know about retirement funding: you can generally “take back” one contribution made to a traditional IRA without a penalty, as long as you do not deduct the contribution from your taxes and take the funds out before the year’s tax deadline.
If Your Situation Is Truly Dire…
Sometimes, you truly need the cash, penalties or not. In those extreme circumstances, you can actually withdraw funds from an IRA in what is referred to as “substantially equal periodic payments.” The payment is determined by the IRS, based on your life expectancy — and you must take that amount. This is a strictly regulated option. You cannot change this arrangement before you attain age 59½ or for five years, whichever period is longer. Stopping or canceling incurs a 10% penalty, retroactive to the date you first began the payments.
With all of these time constraints, this is not a terrific choice for those under 50. Even if you are over 50, however, this qualifies as a worst-case-only option: it whittles away your funding for when you are actually retired, and that is a terrible time to come up short.
A retirement funding shortfall is not something anyone wants, and guidance from Andrew M. Lamkin can help you balance emergency cash needs and sensible funding for your future. Call the Law Office of Andrew M. Lamkin at 516-615-0625 and ask about an initial consultation, free of charge.