Withdrawal Penalties Can Take A Bite Out of Retirement Savings
TAKING A BITE OUT OF RETIREMENT SAVINGS
You've been putting aside funds into your 401(k) or IRA each payday with an eye toward building up a retirement nest-egg. You want to keep those funds working for you, year after year, so that by the time you reach your mid 60s you can tap your savings to supplement social security. But sometimes we need to dip into that cash before we retire. A job loss, a medical emergency or other pressing need may force you to consider an early withdrawal from these accounts. While it's nice to have that pool of money available, accessing it before a certain age can be very expensive.
SOME MAGIC NUMBERS: 10, 25, 55, 59.5 AND 70.5
Early withdrawals from retirement accounts can trigger penalties and taxes due that can drastically reduce the amount of cash that you can realize. The penalties depend on a number of factors including your age and what the withdrawn funds are used for. You will normally face a 10% penalty on funds withdrawn before you turn 59 1/2 plus you must pay taxes on that amount. For someone who is 40 years of age taking $10,000 from their account and who is in the 28% tax bracket, your withdrawal penalty and taxes due will be $3800 (10,000 x 38%). If you have a SIMPLE IRA and you have been contributing to it for less than two years, your early withdrawal penalty is 25% plus the taxes due.
The rules are different for 401(k) and other similar plans. You may withdraw funds without penalty if you leave your job after you turn 55, but taxes will still be due. And, lastly, the grand-daddy penalty of them all: the levy for not taking a required minimum distribution when you turn 70 1/2. You must begin withdrawing a set amount of money each year or face a 50% penalty. To see the specific rules and calculate what your required minimum distribution must be, see the IRS site http://www.irs.gov/retirement/article/0,,id=96989,00.html#1 .
EXCEPTIONS TO THE RULE
The good news is that there are some exceptions to most of the penalty rules. According to About.com you can avoid the 10% IRA penalty on your distributions for the following reasons:
- You used a "direct rollover" to another qualified retirement account
- You were permanently or totally disabled
- You were unemployed and used the funds to purchase health insurance
- You paid for college expenses for you or your dependent
- You were a first-time home buyer (their are certain restrictions)
- You paid certain medical expenses (again, some restrictions)
- The IRS levied your account to pay off tax debts.
Exceptions for 401(k) and 403(b) plans:
- Distributions upon death or disability of plan participant
- You were age 55 or over when you retired or left your job
- You received "substantially equal payments" over your lifetime
- You paid certain medical expenses
- Distributions were required by a divorce decree or separation agreement.
As always, never make a move without consulting a qualified professional (CPA or attorney) especially if significant amounts of money are involved or you have complicated legal issues.
In the case of workplace plans (401k) you often have the option of accessing your money through a loan, but there are other considerations involved and those will be addressed in a future article. For now understand that penalties and taxes due can take a substantial bite out of your retirement funds and should only be used after careful consideration.
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