In the current economy, a retirement plan, IRA, 401(K), or other qualified plan, is often a family’s largest asset. With loans difficult to obtain, accessing retirement funds may be critical, especially if you can do without early-withdrawal penalties. The general rule is that for persons under the age of 59 ½ early withdrawal costs a 10% penalty and is often the reason people do not use retirement money early.
It is estimated that 15% of participants have taken some form of early withdrawal. Recently, the IRS has given guidance regarding early withdrawals from retirement plans. There are various methods of taking early (i.e., pre-59 ½) withdrawals from 401(k) and IRA’s without incurring the 10 percent penalty.
Many times, different rules apply for 401(k) and other qualified plans as opposed to various forms of IRAs. The rules are the same for penalty-free withdrawals from a 401(k) or IRA if the account owner:
- Is totally disabled;
- Has medical expenses exceeding 7.5 percent of adjusted gross income;
- Is required by law to give money to a divorced spouse;
- Is permanently laid off, terminated, has quit work, or has taken an early retirement in the year the account owner turned 55 or later; or
- Takes withdrawals in substantially equal amounts over the owner’s life expectancy that:
1. Must be paid at least once each year;
2. Must be based on the life expectancy of the plan participant or the joint life expectancy of the participant and a designated beneficiary; and
3. Must not be modified before the later of five years after the first distribution or date on which the plan participant reaches age 59 ½.
In addition to the above, there are additional means of withdrawing funds pre-59 ½ years of age from an IRA (but not a 401(k)):
- To pay health insurance premiums during a period of unemployment that lasts at least 12 consecutive weeks.;
- To pay for higher-education expenses for the account owner’s spouse, child, or grandchild, but only if the distribution is used to pay for tuition, fees, books, supplies, equipment, or room and board and is net of any scholarships; or
- To pay up to $10,000 of the cost of purchasing (not refinancing) a first home, defined as someone who did not own (and whose spouse did not own) a principle residence in the two years preceding the distribution from the account.
A 401(k) plan may also allow employees to receive a hardship distribution if there is an “immediate and heavy financial need,” and if the distribution is “necessary to satisfy that financial need.” But, hardship distributions from a 401(k) plan are limited to the amount of the employee’s contributions and generally, do not include any income earned on the deferred amounts.