While it’s usually best to avoid withdrawing from your retirement funds early, there are a few special situations when it can be advantageous to do so. Discover which scenarios might legitimize this transaction and learn how you can minimize early withdrawal penalties if you choose to go this route.
Special circumstances to withdraw retirement savings
According to Nancy Mann Jackson, contributor with CNBC, there are three exceptions to the general rule of not withdrawing your retirement early: medical reasons, education and buying a home for the first time.
A serious illness, particularly a terminal one, is usually associated with expensive medical bills that you might not have budgeted for. As Kevin Mercadante, contributor with Investor Junkie, explains, “It makes no sense to keep your retirement plan intact for ‘someday.’ Your someday is now, as in now is when you need funds.”
However, you should only do an early withdrawal if your medical condition falls under strict criterion. Eleanor Blayney, financial planner and consumer advocate for the Certified Financial Planner Board of Standards, recommends doing so only “If you are terminally ill, need money for medical expenses, and are not expected to live to retirement age.”
Loans for higher education are another circumstance that might tempt you to dig into your retirement funds. Ben Barzideh, wealth advisor at Piershale Financial Group in Crystal Lake, Illinois, advises against this, however. “Your children can work and take out loans to pay for their own college. You can't take a loan out to pay for your retirement if you haven't saved enough… [Never] sacrifice your own retirement to pay for your children's education."
If you’re buying your first house, you might consider tapping into your retirement savings. Financial specialists usually tend to agree that this item is a sensible reason for making an early withdrawal. As Barzideh expresses, a first-time home is an investment that will usually give you a return in the long-term.
How and when you can avoid early withdrawal penalties
Depending on the reason you’re withdrawing retirement funds early, you might be able to avoid paying certain penalty fees.
For instance, this is possible if you’re facing a serious illness and withdraw the funds from either an IRA or 401(k) plan. Mercadante states that if you’re under 65 years of age, the IRS will waive the 10 percent early withdrawal penalty fee, as long as you use the money to pay for medical expenses that are more than 10 percent of your adjusted gross income (AGI).
According to Jackson, if you’re buying your first home, you won’t have to pay penalty fees for early withdrawal if you meet the following conditions: first, you haven’t owned a home in the past two years and second, the property you’re purchasing is your first home.
Consider an alternative
Besides making an early withdrawal, you might want to pursue an alternative path: taking a loan from your retirement account. As Blayney explains, “Loans are limited to a certain amount — up to the lesser of $50,000 or 50 percent of account balance, and you have to pay it back generally within five years.” This can save you money in the long run, by opting for this type of loan instead of making an early withdrawal and paying the associated penalty fees.
Make sure you consider the pros and cons involved with an early withdrawal from your retirement funds. As long as you have an extenuating circumstance and follow some guidelines to avoid early withdrawal fees, this route is a feasible (although not ideal) one to pursue.