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- There are two ways to withdraw from your retirement accounts — both result in penalties.
- You can take out a loan against your account, but you’d need to make regular repayments.
- Seek out alternate methods in order to keep your retirement fund strong.
Matt and Terri O’Reilly of Sacramento, California took their retirement savings seriously. They both worked at good jobs and every year they put 10% to 15% of their income into some type of retirement investment. So, in their mid-fifties, with approximately five times their annual income saved in various retirement accounts and enough emergency money set aside to cover six months of expenses, they felt financially secure. Their daughter was in her junior year at college, and their son was finishing high school and waiting on his college applications.
Trouble started when Terri got into a traffic accident that left her with neck and back injuries and a smashed knee. It would be months before she could return to work. Meanwhile, Matt’s employer lost some big clients and had to cut back costs, so Matt got laid off from his job.
Suddenly, the O’Reillys were facing significant medical expenses and months of reduced income. Medical, disability and unemployment insurance helped but it was also the beginning of the Great Recession. Matt was unable to find a job in his field and had to take part-time work at a mini-mart. When Terri was ready to go back to work, her employer couldn’t afford to take her back. The O’Reillys, who had always managed their finances well, were getting close to running out of money and to make matters worse, they were supporting two children in college at the same time. At that point, Matt and Terri started thinking about making the major decision of withdrawing money they needed from their retirement savings, even though most retirement advisers discourage anyone from doing that.
Common Ways to Access Retirement Funds
There are two common ways to access the money in your retirement accounts: taking an early withdrawal or taking a loan against your retirement account balance. Each might seem like a good idea at the time, but they are prime reasons why so many people have little or no retirement savings.
Early Retirement Fund Withdrawals
If you decide to take an early withdrawal from your retirement account, there are some basic rules you’ll need to be aware of before making that decision. For example, you, typically, need to leave money in your retirement plan until you turn 59 ½ years of age. If you withdraw funds early, the money you withdraw will be taxed as ordinary income and may incur the 10% early withdrawal penalty. You might not be subject to the 10% penalty if you are withdrawing money to pay for college for a family member (IRAs and Roth IRAs only) or if you separated from your employer after age 55 (employer plans only).
You also might avoid the penalty if you are unemployed and paying health insurance premiums) or if you are unemployed or employed and your medical bills total more than 10% of your adjusted gross income. Internal Revenue Service early withdrawal guidelines allow you to withdraw up to $10,000 without penalty if you are buying a first home. (See: IRS, Early Distribution from Retirement Plans May Have a Tax Impact, IRS Tax Tip 2012-34, February 21, 2012).
Taking a Loan Against Your Retirement Account Balance
If you need a sum of money to meet a temporary shortfall in cash and will be able to pay it all back within a few months, a loan against your qualified plan might make sense. Check with your plan administrator regarding rules for borrowing against your retirement account balance. These rules can vary, and some plans don’t allow loans. You can’t take a loan from your IRAs, SEPs, SARSEPs, Roth IRAs or other IRA-based retirement accounts. You can’t even use your IRA as collateral for a loan because that can invalidate some or all of your IRA account. It is a little easier to borrow from a qualified plan such as a 401(k), 403(b), or government retirement plan (457(b)).
If you take out a loan, you must make regular repayments. If you don’t make a payment for 90 days, your loan will be considered a distribution, will be taxed as ordinary income and will incur a 10% penalty if you are younger than 59 ½ years. Furthermore, if you lose your job while the loan is outstanding, you must pay it off within 60 days. Another option after the Tax Cuts and Jobs Act of 2017 is to roll the amount of the unpaid loan into an IRA or other employer plan by the due date of the return that included the loan default period, including extensions. So, before you make any decisions, contact your financial planner. (See: IRS, Retirement Plans FAQs regarding Loans).
The Smarter Thing to Do
Alternatives to raiding your retirement savings include borrowing against or selling assets like cars, boats or jewelry. A part-time job is preferable to not having enough money to retire comfortably because you used your retirement savings to cover expenses. Credit cards are also a potential solution. However, nothing is better than establishing a strict budget that will provide for accumulating an emergency fund and paying into your retirement fund, even if you must reduce your lifestyle.
What You Can Do Next
The biggest reason for not raiding your retirement savings early is the reality that you will need the money for retirement. That is why financial professionals warn against tapping into your retirement savings. Options such as lifestyle changes and financial strategies are recommended. Proactive planning and preparing is always the best solution. But, if you didn’t do that, any time is the right time to start working with a financial professional. Please consult your tax and legal advisors for advice concerning your particular circumstances.
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