Can You Use Your 401(k) or IRA for Income?
Supporting yourself with income from a 401(k) or traditional IRA is expensive if you're younger than 59 1/2. At that age, you can withdraw money at will; until then, you pay a 10 percent tax penalty on most withdrawals in addition to regular income tax. If you've inherited a retirement account, you can use withdrawals for income at any age without a penalty. Owners can only do so in special cases.
Take money out of your IRA for day-to-day expenses and you pay the 10 percent penalty. IRS Publication 590 gives a list of expenses you can spend the money on without penalty. For instance, you can use the money to pay health insurance premiums, or to pay medical expenses greater than 7.5 percent of your adjusted gross income. Paying for college tuition or a first house from your IRA is also okay. You still pay income tax on your withdrawals, however.
Like an IRA, you can legally tap into your 401(k) in a crisis, but the requirements are tougher. You can take money out to pay for medical expenses, tuition or housing but not if you have other money available -- including financial help from your spouse or your kids. The withdrawals are only an option if your plan allows hardship distributions, and if you provide proof to the plan manager that you need the money. Once you make a withdrawal, you can't contribute to your account again for another six months.
If you have a Roth IRA, it's much easier to tap into the money you deposited in the account. Starting five years after you open your account, you're free to withdraw any of your contributions. You already paid tax on the money so there's no cost to take it out. If you withdraw earnings before 59 1/2, they're taxable income and you face the 10 percent penalty. You can, however, avoid the penalty by using the money for the same exempt spending as applies to traditional IRAs.
If you need regular money for regular expenses, borrowing from a 401(k) is usually better than withdrawing cash. You can take a loan for any reason, and there's no income tax or penalty unless you fail to repay the money. The interest is low, and it all goes back into your account, rather than to a bank. Like hardship withdrawals, it's up to your employer to decide if you can borrow from your 401(k) plan but many employers allow it.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.