Recently, I was asked about dipping into retirement accounts early; does withdrawing funds before age 59 1/2 always come with penalties attached? While in most cases, it's best to consider your retirement money "untouchable," but life does happen -- and certain situations may necessitate early withdrawal.
Fortunately, there are ways to access your retirement savings before you're actually retired while avoiding the dreaded 10 percent early distribution penalty. Here are 5 not-so-obvious ways to get your retirement cash early.
1. Investment Management Solution: Take Back Your Roth Contribution
Under normal circumstances, after-tax contributions placed in a Roth IRA are tax-free after five years and after age 59 1/2. However, if you are in need of cash, you can withdraw your initial contributions at any time, without incurring penalties or taxes. Note that this rule applies to initial contributions only, not earnings.
Be careful, because if you take out more than you've contributed, the IRS will classify it as rollover funds or earnings and you'll have to pay income taxes, and possibly penalties, as well.
2. Ask Your Retirement Planning Advisor About Substantially Equal Periodic Payments
Thanks to a little-known section of the Internal Revenue Code known as section 71(t)(2)(iv), you can receive regular payouts from your IRA, regardless of age or reason. The IRS determines payout amounts by dividing the balance of your IRA account by your life expectancy.
While these withdrawals are free from penalties, they're not exactly free from all strings. Once you begin to receive payments, you can't stop for at least 5 years or until you reach the age of 59 1/2 (whichever takes longer). If you do elect to stop taking payments, you'll get slammed with the 10% penalty tax -- and it's retroactive, so you'll owe from the first disbursement.
3. Wealth Management Solutions: Work Until After 55
Hang in there just a bit longer and leave a job in the same calendar year in which you turn 55 or older. Then you can take funds from the 401(k) associated with that particular job without paying a penalty -- even if you quit that job to take a position with another employer. Keep 401(k) rollover options in mind, however; if you roll that 401(k) into an IRA, you'll have to pay those IRA penalties if you withdraw funds before age 59 1/2.
4. Inherited IRAs and Strategic Financial Planning
If you're a named beneficiary of someone else's IRA, i.e. if you "inherit" the account, you can withdraw without penalty, regardless of your age. One caveat: If you inherit the IRA from a spouse you can roll it into your own name -- but then you'll have to pay penalties if you withdraw before 59 1/2.
5. Financial Strategies: Penalty Waivers and Hardship Withdrawals
Using IRA funds to pay for college tuition, fees, books and -- for full-time students -- room and board costs for yourself, your children or grandchildren. Note: Withdrawals will count as taxable income, thus creating the potential to limit financial aid eligibility in the future the IRS allows penalty-free early withdrawal from pre-tax IRAs -- but not 401(k)s -- in certain circumstances. These include:
- Tapping into your IRA to buy your first home; you can take out up to $10,000.
- Using IRA funds to pay for health insurance; to qualify, you must be unemployed and on unemployment insurance for at least 12 weeks and take the withdrawal up to 60 days after starting a new job.
In addition, you can withdraw without penalty from an IRA or 401(k) to pay for qualifying medical expenses. Proceed with caution, however, because costs must exceed a certain percentage of your adjusted gross income to qualify and you have to pay these costs in the same year that you make the withdrawal. Speak with your trusted retirement planning advisor and tax professional to iron out the details.