It is possible to withdraw funds from a retirement account before you reach the minimum age, but you’ll incur substantial penalties and you risk compromising your long-term financial security. A smarter move is to roll these funds into another tax-protected retirement vehicle. If you absolutely need the money to survive between jobs, the IRS allows some very limited exceptions to the penalties.
If you withdraw your entire retirement fund balance as a lump sum before you reach the age of 59 1/2, you must pay federal and state income tax on the pre-tax portion as if it were salary or wages. The Internal Revenue Service requires your employer to withhold 20 percent up front toward your federal income tax, but you may be liable for additional taxes when you file your tax return. If you are under the minimum age, the IRS also will levy a 10 percent early withdrawal penalty.
You cannot avoid paying income taxes on money you withdraw from your retirement fund, but a few exceptions are available that may help you to avoid paying the 10 percent penalty on top of the other taxes. Under current IRS rules, you can make a penalty-free withdrawal from your IRA if you use the money for qualified medical expenses or for education at an approved institution. Additionally, in most cases, you can access these funds without penalty if you are fully disabled. If you are unemployed, you may withdraw funds without penalty to pay health insurance premiums. For non-IRA retirement programs, your employer is not obligated offer these exceptions, so consult the fine print of your contract to determine which exceptions apply to your account. Some 401(k) plans also allow you to withdraw money without penalty to avoid foreclosure or eviction.
If you don’t need to use all the money in your retirement account, consider leaving at least some of it in the existing account. This is the best way to avoid taxes and penalties. If your funds are not in an IRA, you can roll the account balance into a new or existing IRA to avoid taxes and penalties. An IRA is a good way to consolidate all your retirement funds, which makes record keeping much easier. Another option is to combine your retirement funds and your spouse’s into a single IRA account. If your retirement funds are in an IRA, you can avoid penalties – but not income taxes – by withdrawing the money in equal payments over the remainder of your life expectancy. Once you begin this distribution, however, you can no longer contribute to the account for future retirement.
While it may be tempting to have that extra cash in hand despite the penalties, withdrawing funds from a retirement account has longer-term consequences. You will have to increase your future contributions to meet the same retirement nest egg goal and, even if you pay back the amount you withdrew, the earnings your money would have accrued in the account is lost. To avoid penalties in the future, set up an emergency fund that you can tap into for unforeseen events or if you find yourself between jobs and without income.
- TIAA CREF; Withdrawals From Retirement Plan
- SmartMoney.com; Tapping Into Your Retirement 401(k) Before You Retire; July 2010
- Bankrate.com; Penalty-free 401(k), IRA Withdrawals; Sheyna Steiner; March 2010
- Bankrate.com; One Way to Avoid IRA Early Withdrawal Penalty; George Saenz; November 2010
- Internal Revenue Service: Individual Retirement Accounts (IRAs)
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