Let’s face it; life happens. It is almost inevitable that a situation will arise in which you will need a significant amount of money in a limited amount of time. When this happens, most people turn to their savings. But, what if your only access to cash is through your retirement plan? You heard that you will be penalized for taking the money out before “time.” Well, what is that timeframe, and what if you are experiencing an emergency and you need cash now? Will the IRS waive the penalties? The short answer is in certain situations, yes.
An early withdrawal from an retirement account typically means taking money out of the account before you reach the age 59 ½ . All early withdrawals are reported to the IRS, and are subject to a 10% tax penalty in addition to any income taxes that may be owed on the withdrawal amount. However, the 10% penalty does not apply to nontaxable withdrawals. One type of nontaxable withdrawals are withdrawals used to pay for the cost to participate in the plan. This includes contributions that were pre-taxed before you put them into the plan. Another type of nontaxable withdrawal is a rollover. A rollover occurs when you take a withdrawal from one plan and contribute the amount to another plan. Typically you have 60 days to complete the rollover transaction.
That leads us back to our central question: What if I need money now? The IRS does allow exceptions to the 10% penalty in certain situations. However, the exceptions also depends upon the plan. For purposes of this post, we will only examine the exceptions of IRAs and 401(k)s. Also, we will only list the exceptions pertaining to “life emergencies.” The first exception is if the plan participant (you) becomes totally and permanently disabled. The exception applies to both 401(k) and IRA’s.
The next exception is for the death. Naturally, both IRAs and 401(k) s allow an exception for the death of the plan participant/owner. There is also an exception for qualified higher education expenses (college tuition). This exception only applies to an IRA. To be eligible, the expenses must be for yourself, a spouse, child, or grandchild. The student must be a full time student (enrolled more than half-time), and the expenses must be for qualified education expenses (books, tuition, etc.). Moreover, an IRA allows you to withdrawal up to $10,000.00 penalty free to purchase your first home. If you find yourself in trouble with the IRS, and the IRS levies (seizes) the money from your retirement plan, of course, both plans allow an exception to the penalty. Another exception that applies to both plans is if the money is used for unreimbursed medical expenses. So, as you can see, in limited situations you are allowed to access funds from your retirement without being penalized. Although, keep in mind that the withdrawals from the plans are still taxable. The only exception is to the additional 10% penalty.
Always, before you make a withdrawal, please consult with your plan administrator and/or tax professional.
For additional information regarding this post, please contact our office.