The Internal Revenue Service assesses penalties for unqualified early withdrawals from individual retirement accounts to discourage people from pulling money out of their IRA prior to retirement. In some cases, however, people lose their jobs and they have no other choice but to raid their IRA for living expenses.
Congress established the traditional IRA plan in the Tax Reform Act of 1986; the Roth IRA was born in the Taxpayer Relief Act of 1997. Congress developed these retirement plans to give people the opportunity to plan for their retirement independently from their employer. The point was to make certain people could sustain their quality of life upon retirement, not to use the accounts as savings accounts upon which they could draw money from whenever they needed it.
Because the money is meant to stay in the IRA until retirement age, which the IRS designates as 59 1/2, the IRS assesses a 10-percent penalty on any unqualified funds withdrawn from the IRA early. There are exceptions for both traditional and Roth IRAs to this rule for certain financial hardships that might be tied to unemployment. They are:
-- Incurring an excessive amount of non-reimbursed medical expenses that exceed 7.5 percent of your adjusted gross income.
-- Tapping into your IRA to help pay for your medical insurance premiums while unemployed, allowing you to keep your coverage until you get hired elsewhere and receive new coverage.
-- Permanent physical or mental disability that prevents you from performing any employed duty. Your disability must be extensive and expected to result in death or an incapacity to work for an indefinite time period.
Another option is to take what the IRS dubs "substantially equal periodic payments" from your IRA while unemployed. The pro to funding your unemployment hardship this way is you receive periodic income from your IRA penalty-free; the con is you have take the payments for a total of five years, unless you turn 59 1/2 before the time frame is up. This will cut significantly into your retirement savings in the long haul. You must calculate the amount of your periodic payments using one of three IRS-approved methods: required minimum distribution, fixed amortization or fixed annuitization method. For example, using the required minimum distribution method, your periodic payments would be calculated by dividing the balance of your IRA annually by your life expectancy factor as set forth in the IRS life expectancy tables.
You might be in better shape if you are thinking about pulling the money out of your Roth IRA to help you with your living expenses while you are unemployed. Roth IRAs are special in that you may take out your contributions at any time for any reason -- you’ve paid the taxes on them, so you won't get dinged with an early distribution penalty if you pull from your contributions. If you need more money and have to tap into your Roth’s earnings, however, you’ll be penalized on any unqualified distributions, unless you are 59 1/2 and your Roth IRA has been open for five years or more.
If you become unemployed and must tap into your IRA, keep in mind that you will still have to pay taxes on any traditional IRA distribution -- regardless of its qualification -- because you didn’t pay taxes when you put the money into the account.
- Internal Revenue Service: Early Distributions
- Internal Revenue Service: Roth IRAs
- Internal Revenue Service: Tax Topic 557 -- Additional Tax on Early Distributions from Traditional and ROTH IRAs
- Forbes: IRA Penalty Relief for Great Recession Hardship Withdrawals Proposed
- Bankrate.com: IRS Rules for Early IRA Withdrawals
- CNN Money Ultimate Guide to Retirement: When Can I Take Money Out of a Roth?
- Internal Revenue Service: Retirement Plans FAQs Regarding Substantially Equal Periodic Payments
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