Beware the IRS Man Cometh!
Taking money from your retirement accounts is allowed, if you follow the rules. If you don’t, it could be costly. First off, if you take money from a retirement plan (like an IRA, 401K, 403b), you will need to pay income tax because this income has been deferred from taxation to date. Loans are not allowed from an IRA but loans from 401K’s are not taxable if paid back within the IRS prescribed timeframe.
If you need money and you’re over 59 ½, good news, you won’t be hit with a penalty on the amount withdrawn, just the income tax. For everyone else, you have 60 days to return all funds back to an IRA or face a 10% penalty plus income tax on the amount taken out. There are exceptions to help avoid the 10% penalty. For example, in the event of a death or disability of the account holder, funds can be distributed without penalty. Another is medical expenses that exceed your adjusted gross income by the current 10% limit or withdrawals used for a ROTH IRA conversion.
Many get tripped up thinking taking money out for the purchase of a new home or paying for higher education expenses is also penalty free. While taking money out for these two reasons is an exception from the penalty, it only applies to an IRA, it doesn’t apply to a corporate plan like a 401K. And pulling money out that is the result of a qualified domestic relations order (QDRO) due to divorce is a penalty free exemption from a company plan but it doesn’t apply to IRAs. The same holds true for the age 55 early retirement rule.
If you do really need money and your retirement account is the only place to turn, consider utilizing the IRA exemption 72(t). This exemption allows you to take money from any retirement plan so long as you take it out in (substantially) equal periodic payments. You can stop the payments once you’ve reached the age of 59 ½ and you’ve received at least five years’ worth of payments. Taking money from a retirement account can be costly if you don’t know the rules. Always talk to your financial and tax advisors before potentially making an expensive distribution mistake.