It’s important to save for retirement, and the tax advantages are great, but what if you need your money now? If you need to dip into your retirement savings, there are plenty of ways to go about it. But all of the specific rules make it confusing.
To make it easier, here are a list of options for withdrawing money early. Along with those options are all the rules and stipulations you should keep in mind.
Generally, you can’t (and shouldn’t, if you can help it) take money out of a retirement account until you reach age 59½. If you do, you’ll be subject to an early withdrawal tax, which is 10% of the amount withdrawn (yikes). There are exceptions to this, and we’ll point them out when they apply. (There’s also an umbrella exception for military active duty, and you can read more about that here.)
Take out a Loan from Your 401(k)
If you have a 401(k) or 403(b) and you need money now, most employer-sponsored plans will let you borrow from the account. You’ll have to pay this money back, but you should do that anyway. You want to replenish your nest egg, no matter how you borrow money from it.
Of course, there are limits. You can borrow up to $ 50,000 or 50% of your account balance, whichever is less. You’ll have five years to pay the money back, with interest. Of course, that money goes back into your retirement account, including the interest. In fact, calling it “interest” is a little misleading, because the money goes back to you, anyway.
Because it’s a loan, the money you borrow is tax exempt. You will, however, be taxed on the interest—twice. First, you’re already paying for interest with your after-tax dollars. Second, because the interest goes back into your account, you’ll also be taxed on it when you withdraw it at retirement. Basically, you’re being taxed on after-tax money.
Also, let’s say you borrow the money, and, before paying it back, you lose your job. According to Forbes, your former employer will probably want you to pay that money back quickly. And if you don’t, they might treat your outstanding balance as an early distribution, and you’ll have to pay penalties.
Take a Hardship Withdrawal
But if you think money will be tight and you’ll have trouble repaying the loan, you might consider using the hardship exception available to most 401(k)s. In order for your situation to be considered a hardship, the IRS says there has to be an “immediate and heavy” need. Here’s what this means, according to their site:
Certain expenses are deemed to be immediate and heavy, including: (1) certain medical expenses; (2) costs relating to the purchase of a principal residence; (3) tuition and related educational fees and expenses; (4) payments necessary to prevent eviction from, or foreclosure on, a principal residence; (5) burial or funeral expenses; and (6) certain expenses for the repair of damage to the employee’s principal residence. Expenses for the purchase of a boat or television would generally not qualify for a hardship distribution. A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee.
If you have an employer-sponsored account, your employer doesn’t have to allow this, but most do. Here’s the catch, though. Depending on the hardship, you might have to pay a 10% early withdrawal tax, or penalty, on the amount you take out. For example, you can withdraw money for education expenses, but you’ll pay that penalty. For that reason, the 401(k) loan is usually the better option.
The IRS has a handy chart that tells you what scenarios are exempt from this penalty, depending on what the hardship is and depending on the type of retirement account.
These hardship withdrawals apply to IRAs, too. And IRAs have more penalty-free options.
Withdraw Your Roth IRA Contributions
If you have a Roth IRA, you’ve already paid taxes on the contributions. We explain this in more detail here, but it works this way because it’s not a tax-deferred account. Unlike a 401(k) or Traditional IRA, you can’t deduct the money you save in a Roth IRA from your taxable income. You pay taxes on it.
Because of this, you can withdraw those contributions whenever you want, for whatever reason, from a Roth IRA. You’ve already paid your taxes, so the IRS doesn’t care. The withdrawal is also penalty-free.
The key word here is contributions. The money in your IRA, ideally, grows. You can’t take out the earnings without penalty, only the original amount that’s actually been contributed (also known as the principal). So you’ll have to prove just how much you’ve contributed over the years. You can get this proof from the company that holds your account.
Aside from this evergreen rule for Roth accounts, there are some specific instances that let you take out IRA money without a penalty.
Use The Education Exception
You can take out IRA money, penalty-free, if it’s used for education for yourself, your spouse, or your kids or grandkids. This works for any type of IRA, and it isn’t limited to contributions, either. You can also take out earnings.
Of course, there are rules. The IRS is pretty straightforward about what counts as an education expense:
…these expenses are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. In addition, if the student is at least a half-time student, room and board are qualified education expenses.
What’s more, the institution has to be approved by the IRS, too. Chances are, that won’t be a problem: it includes “all accredited public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions,” according to the IRS.
Any money you take out of the account will be taxed if it hasn’t been already. That’s true for any of these scenarios.
Use The “First Home” Exception
Buying your first home? You can take out $ 10,000 from your IRA to put toward the cost. If you’re married, and both you and your spouse are first-time homebuyers, you can both pull from your IRAs. That gives you $ 20,000 to put toward your first home. The rule is pretty flexible, too. You don’t necessarily have to be purchasing your very first home, just your very first “principal residence.” If you haven’t owned a principal residence at any time during the previous two years, you might qualify. This means, if you bought a vacation home somewhere, you could still qualify for this exception. And you can also use the exception to help a child, grandchild, or parent.
There are a few stipulations. You have to use the money within 120 days of the withdrawal. You can use it for principal residential properties only, and it can be used for any costs related to buying, building, rebuilding, financing, or closing costs.
Of course, this is a withdrawal, so if you have a Traditional IRA, you’ll pay taxes on the amount you pull. And there are some special rules for Roth IRAs, too.
Special Rules for Roth
Once again, you’ve already paid taxes on your Roth contributions. So it might seem like you don’t have to worry about a tax bill for your home-buying money. But when you opened the Roth matters.
If you’ve held your Roth account for more than five years, it’s a qualified distribution, and you don’t have to worry about being taxed for the first-home exception.
But if you opened your Roth IRA less than five years ago, the withdrawal is an early distribution. So while your contributions are tax-free, you may owe taxes on any earnings you withdraw. Bankrate explains how to get around this:
You can reduce the tax bite by first withdrawing the already-taxed contributions you made to your Roth. In fact, the IRS has specific rules about the order in which you can take unqualified Roth distributions: contributions, conversions from traditional IRAs and earnings.
So basically, withdraw your contributions, and you’ll be fine. If you need more, than you can withdraw your earnings, but you’ll be taxed.
“Take Back” Your IRA Contribution
Let’s say you’re an awesome saver. You’re so awesome at saving that you’ve actually saved a little more than you wanted in your IRA, and now you’re short on cash.
The IRS offers something called a “take back” contribution. You can take back one contribution made to your traditional IRA without having to pay tax on it. You’ll have to do this before you file taxes for that year, and, of course, you can’t defer that contribution from your income. You’re taking it back, after all.
If you’re in a pinch, and you have a traditional IRA, it’s something to consider. Zacks has more detail on this, including step-by-step instructions on how to do it.
Borrow Money From Your Rollover
Here’s a somewhat risky IRA workaround if you need a little more cash. You can roll over your Traditional IRA to a Roth IRA and then borrow that money. The rollover has to be completed within 60 days, but you’ll have access to the money during this time. If you think you can pay it back in 60 days, it might be an option for you. Fail to pay any of it back, though, and you’ll face the penalty.
Bankrate points out that this isn’t a revolving loan. So you can’t cheat the system by moving the money back into your Traditional IRA and then initiating another rollover. According to the IRS:
Generally, if you make a tax-free rollover of any part of a distribution from a traditional IRA, you cannot, within a one-year period, make a tax-free rollover of any later distribution from that same IRA. You also cannot make a tax-free rollover of any amount distributed, within the same one-year period, from the IRA into which you made the tax-free rollover.
This may be obvious, but it’s worth pointing out.
Take “Substantially Equal Periodic Payments”
A lesser-known option, according to Forbes, is taking out substantially equal periodic payments. The catch, they say, is you have to continue taking these payments for five years or until you reach age 59½, whichever comes later. They offer a couple of ways to calculate the payments:
In the simplest, which produces the smallest annual payout, you divide the IRA’s total value by your remaining life expectancy. Claudia Hill, president of Tax Mam, in Cupertino, Calif., and a Forbes contributor, recommends you work backwards. First, figure out how much cash you need and then calculate out how big an IRA will produce that annual distribution. Then, split your IRA, with one piece holding just the amount needed to produce your desired annual payout. Later, if you need still more cash before 59 1/2, you can draw it from the second account, without jeopardizing penalty-free distributions from the first.
Once again, you’ll have to pay taxes on any money that hasn’t already been taxed.
Taking money from your retirement isn’t a decision that should be made lightly. There are so many factors to weigh and considerations to make. For example, depending on the type account, withdrawing the money could increase your adjusted gross income, which might affect your eligibility for financial aid. Make sure you’ve considered all the potential effects before you take the plunge.
You also want to make sure to eventually replenish your account. Sure, you might need the money you’ve already saved to buy a house, pay for school, or help you make ends meet in tough times. Just remember, you saved that money for a reason. You don’t want to lose sight of your retirement.