When you’re strapped for cash, you might consider drawing money from your retirement savings fund. However, retirement plans vary greatly in terms of fees, rules and tax liability for early withdrawals. Here’s an overview of factors to consider before you decide to withdraw money from your retirement savings.
Traditional IRA plans
A traditional IRA plan is stocked with your pre-tax money. While this gives you a tax break, this retirement plan prevents you from withdrawing money until you reach age 59 ½. If you tap into your traditional IRA before reaching that age, you’ll incur a 10-percent penalty. However, it’s possible to avoid this pitfall by qualifying for an exception. For example, if you’re a first-time homebuyer, you can withdraw a penalty-free maximum of $10,000 to put towards your house. If you’re married, your spouse can also contribute a penalty-free $10,000 from their traditional IRA. Furthermore, you can take advantage of a fee-free traditional IRA withdrawal if you, your spouse, or a dependent need to cover educational expenses. You can also avoid penalties to pay for medical expenses if the expenses are greater than 10 percent of your adjusted gross income.
Roth IRA plans
When funding a Roth IRA, you contribute your after-tax money. Although this doesn’t yield a tax break, you’re allowed to withdraw penalty-free money from your Roth IRA at any point, to cover any expense, from a romantic weekend getaway to emergency medical expenses. However, according to Maurie Backman, contributor to TheMotleyFool.com, you’re only allowed to draw from your contributions. If you draw from the earnings that your contributions have made, you’ll face a 10 percent penalty.
Much like a Roth IRA, you fund a 401(k) with pre-tax dollars. However, 401(k) plans are far less flexible when it comes to withdrawing money prior to reaching age 59 ½. In the majority of cases, you won’t be able to tap it for funds until you leave your job or the retirement program permits hardship withdrawals. Qualifying hardships include burial expenses, critical home repair, home-buying costs, unanticipated medical expenses, educational fees and payments to avoid foreclosure or eviction from your place of residence. Furthermore, you have to prove that you’re going through hardship to qualify. To find out what kind of proof you need to provide, talk to your 401(k) provider. Even if your hardship qualifies, you’ll have to pay regular income taxes on the money, along with a 10 percent penalty. You won’t have to pay the penalty under a few specific conditions. You’re exempt from the penalty if you’re disabled, you’re court-ordered to pay money to your child, dependent or divorced spouse, or if your medical debts are greater than 7.5 percent of your adjusted gross income. If you don’t qualify for the fee exemption, understand that you’ll probably only receive 70 percent of the amount you withdrew. According to Dana Anspach, a retirement management analyst and contributor to The Balance, you should keep this figure in mind if you’re having trouble deciding whether you’d be better off borrowing money or tapping your retirement fund.
Whenever you withdraw from a retirement savings fund, keep in mind that you’re not just taking out money — you’re limiting its future gains from interest. That said, if you need money to pay for critical needs, your retirement fund can help you out of a financial jam. Before tapping your savings early, talk with your retirement plan provider and financial planner to see what other options are available.