Early 401k/IRA Withdrawals…To do, or not to do, that is the question.

You’ve been “adulting” for a while now, but you are still young as it applies to your retirement. You’ve been working since you were 16, actively contributing to your retirement any time your company offered a plan, and so you have built up a good chunk of change in your 401K or IRA rollover over the years. 

It may be a very tempting idea to “borrow” from your own 401K or IRA a little early. Maybe you’ve been fantasizing about that brand new dream car, or that siren of a cabin cruiser is calling you out to sea, or maybe you just want to quickly payoff that credit card advance you took to play at the big boy table in Vegas…before your wife finds out you took it… 

Well, ok, if you are facing a possible frying pan to the forehead, we can certainly understand the interest in this option, BUT please also consider the other possible impact (no pun intended), that an early withdrawal could have on your financial future, as well as the penalties you may pay to do so. 

An “early” or “premature” withdrawal is any distribution taken from retirement funds before reaching the age of 59 ½. With few exemptions, early withdrawals are subject to a 10% penalty tax, in addition to any federal or state income tax on the withdrawal- and after paying the penalty on top of additional income taxes, you may not have much left in the end to justify the withdrawal in first place- but just for fun, let’s look at what the IRS believes justifies an early withdrawal. 

IRS penalty exemptions differ slightly when comparing a qualified retirement plan to a traditional IRA. Assuming your qualified plan allows for early withdrawals/loans due to a hardship, the IRS does not have a hardship early withdrawal exemption to avoid their 10% penalty. At www.irs.gov, a chart is provided which details the certain withdrawal reasons that may be exempt, but to summarize, most exemptions involve extraordinary circumstances. 

For example, both qualified plans and IRAs are offered an exemption due to the death or permanent disability of the participant/owner. The IRS also offers exemptions for certain distributions to qualified military reservists called to active duty, for certain percentages of unreimbursed medical expenses, and also exempts withdrawals made to correct excess contributions.

Here is where qualified plans and IRAs differ- the IRS offers first-time homebuyers an early withdrawal of up to $10,000 without penalty, and has also allowed for early penalty-free withdrawals for qualified higher education expenses such as tuition, books, or room & board for you, your children, or immediate family, but, as with anything involving the IRS, be aware that all these example exemptions will have their own specific criteria to be met to receive that illusive penalty-free coupon- so please always read the fine print …(as well as the fine print from Raymond James below)

As for that Ferrari on craig’s list…for now, maybe just buy a poster of it?

 

Any opinions within this content are those of the author and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. Neither Raymond James Financial Services nor any Raymond James Financial Advisor renders advice on tax issues, these matters should be discussed with the appropriate professional.