Individual retirement accounts allow you to remove money at any time, which can make it tempting to take out money to pay down debt — even though penalties may apply for IRA withdrawals. Before you raid your retirement account, find out how much it will cost you to take money out of your IRA and remember that once you've taken a permanent distribution, you're not able to make extra payments in the future to rebuild your nest egg.
IRA Withdrawal Penalties
If you're not able to take a qualified distribution, you'll owe an extra 10 percent early withdrawal penalty on the taxable portion of the distribution. Paying debt doesn't exempt you from the penalty. If you're using a traditional IRA, you must be at least 59 1/2 years old to take a qualified distribution. For Roth IRAs, you must be at least 59 1/2 or permanently disabled and the account must be open for five years. If you're getting close to being able to take qualified distributions, you're often better off waiting a few months or years before you withdraw the money.
Roth Contributions Withdrawal
Because of special ordering rules, you're allowed to take out your contributions from your Roth IRA without taxes or penalties, whenever you want. For example, say you've contributed $40,000 to your Roth IRA over the years. You could take out that $40,000 to pay down your debt at any time without paying taxes or penalties. With taxes and the early withdrawal penalty out of the picture, it may make sense to pay off some debt.
IRA Bankruptcy Protection
If your debt is staggering and you face the potential for bankruptcy, you probably shouldn't take any money out of your IRA. If you end up filing bankruptcy, the money in your IRA, up to a certain limit, is exempt from creditors. As of 2012, the limit is $1.17 million. If you were to take that money out, it would be available for creditors to take.
Compare the rate of return on your IRA against the interest rate on your debt before making a final decision. If your debt charges a higher rate than you're earning in your IRA, the interest savings might be worth the taxes and penalties you pay on your IRA withdrawal. Alternatively, if your debt is at a very low interest rate and you are earning a higher rate of return in your IRA, the IRA income makes up for the interest you pay on the debt. In addition, if the debt is deductible like a mortgage, that further reduces the after-tax interest rate on the debt.
Video of the Day
- George Doyle/Stockbyte/Getty Images