Many of us regard our retirement accounts as money best left untapped until we reach our golden years. And it's true that most retirement accounts impose tax penalties or fees for withdrawals prior to age 59½ according to the Internal Revenue Service. But sometimes, financial needs may make us wonder whether we can withdraw money from our accounts earlier.
The IRS notes that in some cases, penalty-free withdrawals are possible before age 59½. That makes your retirement account fair game for funding certain qualified expenses, such as first-time home buying and some health care or educational costs. The rules vary by retirement account type, so we'll examine the early withdrawal criteria for three of the most popular: 401(k)s, Roth Individual Retirement Accounts (IRAs) and traditional IRAs.
Roth IRAs differ from traditional IRA's in a very important respect: You pay taxes on your contributions up front, rather than when you take distributions, according to the IRS. A big benefit of this is that since you've already paid taxes on your contributions, you can withdraw these contributed funds at any time free of penalty. That's right — you can withdraw your contributions at any time and for any reason penalty-free, according to CNN Money.
It's important to note, however, that this benefit only applies to your contributions (that's the money you put into the account). Early withdrawals on any gains or earnings (such as interest, dividends, or stock gains) do face limitations, the IRS says. It notes that you'll face a 10 percent penalty on any early withdrawals of investment earnings.
CNN Money gives the following example: If you have $100,000 in your Roth account — $50,000 in contributions and $50,000 in earnings — and want to withdraw $60,000, you wouldn't face any penalties on the first $50,000 (your contributed amount). The remaining $10,000 you withdraw from earnings would be subject to the 10 percent penalty.
But there are ways around the earnings early withdrawal penalty, too. Certain qualified expenses — such as higher education costs, purchasing a first home, and health care expenses — can be withdrawn from contributions or earnings without penalty at any time. (Check the IRS website for more specifics.)
Most withdrawals from a traditional IRA made prior to age 59½ face a 10 percent penalty, barring some important exceptions. According to the IRS, the following are some qualifying expenses free from early withdrawal penalties:
- Up to $10,000 for first-time home buyers.
- Health insurance costs while unemployed.
- Medical costs exceeding 10 percent of your Adjusted Gross Income.
- Qualified higher education expenses.
- Death or total disability of the plan participant.
After age 59½, you can withdraw funds from your IRA plan penalty-free at any time. Keep in mind, however, that you may be subject to state and federal income taxes due, says Fidelity
According to Intuit TurboTax, you're generally not able to withdraw funds from a 401(k) plan prior to age 59½. Some exceptions exist, including death and disability of the plan participant and certain medical expenses, according to the IRS. These qualifying situations are exempt from the 10 percent tax penalty.
The IRS notes, however, that some plans may choose to offer additional hardship distributions for qualifying situations. If offered by your plan, these hardship distributions enable early withdrawal of funds subject to a 10 percent penalty and state and federal taxes. These hardship distributions must be used to fulfill an "immediate and heavy" financial need as defined by the IRS and must not exceed the cost needed to pay for the obligations. Qualifying hardship withdrawal scenarios, according to the IRS, include:
- Funeral expenses for the plan participant or immediate family members.
- Medical care expenses for the employee, dependents, or immediate family.
- Certain expenses necessary to repair a primary residence or to avoid eviction or foreclosure on the mortgage of that primary residence.
- Certain tuition or educational costs for the employee, dependents, or immediate family.
Depending upon the plan, additional hardship expenses may be covered. Check with your plan provider for further information on qualifying hardship withdrawals from your 401(k) or IRA plans.