Life is full of curveballs. We occasionally get questions about tapping into retirement accounts to cover unexpected expenses. If you’ve wondered about accessing the money in your 401(k) or IRA, you’re not alone. A recent study found that more than half of investors between the ages of 18 and 34 have tapped into their retirement accounts. In some cases, this could be the right move, or there might not be a better option. Regardless, it can be helpful to know the rules ahead of time.
Tax advantaged savings accounts – notably 401(k)s and IRAs—are essentially a tax-bargain with the government. To encourage saving for retirement, these accounts are given preferential tax treatment that allows people to save pre-tax dollars and allows the accounts to grow tax-deferred until distributions are made after the owner turns 59½ years old. Distributions are then taxed as ordinary income. In a world where few employers offer pensions, these types of accounts are usually the bulk of someone’s retirement nest egg.
In exchange for the benefits, there is usually a 10% penalty for “premature” (before age 59½) distributions. This feature means you should weigh your options before deciding to tap into your 401(k) or IRA early, since ordinary income rates plus a 10% penalty can create a substantial tax-bill.
There are some circumstances where this 10% penalty is waived. Aside from catastrophic events like death, disability or medical expenses more than 10% of your AGI, the IRS allows exemptions for education costs, a carveout of up to $10,000 for first-time homebuyers, and health insurance premiums during periods of unemployment. The IRS will also waive penalties if you use your funds to pay tax-levies. This list is not all-inclusive and there are a few more nuanced circumstances, but these are the topics that come up most frequently.
Just because you can access your funds, either with or without penalties, doesn’t mean you should. It’s our recommendation that before you decide to tap into that retirement nest egg you consult your financial advisor and/or talk to your company’s HR department before liquidating part of your 401(k). If we can help with any of these questions just let us know!
This content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. © Twenty Over Ten