You've worked hard for your money, possibly saving for many years for the dream of retirement. You watch your fund grow with the magic of compounding. The growth can seem effortless. You may be tempted to tap into those funds for current needs. It pays to be aware of IRS rules about withdrawals. There are age limits and allowable reasons to withdraw penalty-free. If you tap your retirement funds outside IRS parameters, you could face a painful assessment on the amount you take out. Regardless of your age or financial condition, you should consult a tax adviser before tapping into retirement accounts.
The IRS allows penalty-free withdrawals beginning at age 59 1/2. Before this time, unless you meet certain IRS rules, you stand to face a 10% penalty on the amount you take out, plus possibly income taxes on top of the penalty. The reason for the taxes is that, depending on the retirement account type, you may not yet have paid income taxes on that money. This would be the case with an employer 401(k) plan or regular IRA where your investment is with pre-tax income. At age 70 1/2, the IRS requires a minimum annual distribution based on its life expectancy formula.
The IRS allows a penalty-free distribution for certain medical expenses. If you spend more than 7.5% of your annual income on unreimbursed medical costs, you can generally use IRA funds to pay for health care over that amount without the penalty. Normal income taxes will apply though, and the excess medical expenses must be paid in the same year you take the withdrawal.
You may be able to use retirement funds to pay educational expenses for yourself, or your spouse, child or grandchild. These expenses include tuition, books, supplies, and room and board if the student is enrolled at least half-time. You should be very careful when using retirement funds to pay for college, however, because IRS rules require you to show financial need for the money and that you have exhausted other sources.
If you are a first-time homebuyer, you can withdraw up to $10,000 from a traditional IRA to buy, build, or rebuild your first home. Also, if you have a Roth IRA you can withdraw your original contributions, but not the earnings, without a penalty because Roth deposits are made from after-tax income. If you have a 401(k) through your employer, in most cases you'll want to investigate borrowing against the account instead of an outright withdrawal. IRS rules are more favorable for 401(k) loans for first-time home purchases than an actual withdrawal of funds.
Based in Atlanta, Steve Walker has a 28-year background in commercial and retail banking. Throughout his career, Walker has written extensively on behalf of his small business clients, analyzing their financial condition and making recommendations on their borrowing options. He holds a Bachelors degree in business administration from Furman University.