A sobering study from the Brookings Institution was shared this month. The data shows that an estimated 4 million Americans are currently out of work due to Long Covid. As a financial advisor, we plan extensively for the future retirement needs of our clients, and we also need to discuss the early-withdrawal options to retirement savings.
What if the only choice you have is to take funds from your retirement accounts to keep yourself financially afloat? What if you’re not age 59 1/2 yet when you need to take these withdrawals?
How to Withdraw Retirement Money Without Penalty
Your retirement fund is for, well, retirement, right? You’re not supposed to touch it until you are at least 591/2. That’s why the IRS usually imposes a 10% penalty on early withdrawals from 401(k) and 403(b) plans and Individual Retirement Accounts (IRAs) before you reach that magic age. But sometimes unforeseen expenses pop up and it sure would be nice to tap that nest egg. Here are some circumstances in which you may be able to do that–without paying that 10% penalty:
- You rack up major health care costs that aren’t covered by insurance. IRA distributions can be taken without penalty if you use the funds to pay for unreimbursed medical expenses that exceed 10% of your adjusted gross income. Tally the amount you paid in a given year and subtract 10% of your AGI for that same year. No need to itemize your taxes but it’s a good idea to run your numbers by your tax professional to be sure you’ve calculated correctly.
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- You’re unemployed. You may be able to withdraw health insurance premium costs from your IRA. IF you lose your job and receive unemployment payments for at least 12 consecutive weeks, you can take retirement money to pay for health insurance premiums for you, your spouse and your dependents. The withdrawals must be made in the same year in which you received unemployment compensation.
- You’re paying for college for yourself, your spouse, your children or grandchildren. Eligible expenses include books, tuition, fees and supplies and equipment. The student must attend a college, university or vocational school eligible to participate in federal student aid programs. Note that withdrawals are taxable and might reduce the student’s eligibility for other financial aid.
- You’re buying your first home. You can withdraw up to $10,000 (or up to $20,000 for a couple) from your IRA to help purchase or build your first home. You can also make an early IRA withdrawal to help buy a first home for a parent, child or grandchild.
- You’ve just added to your family. A relatively recent rule change allows new parents to withdraw up to $5,000 following the birth or adoption of a child. You must take the withdrawal within one year of the child’s birth or adoption. And you can put the money back into your retirement account later if your financial situation improves.
- You become disabled. You can tap your IRA without penalty if you develop a physical or mental disability severe enough to prevent you from working for at least a long time, if not ever again. You will need documentation from a medical professional to qualify.
- You go on active military duty. Members of military reserves called to active duty after Sept. 11, 2001, for more than 179 days, may take a penalty-free distribution. The distribution must be taken while you are on active duty. Qualified branches of service include the Air Force Reserve, Air National Guard, Army National Guard, Army Reserve, Coast Guard Reserve, Marine Corps Reserve, Naval Reserve or Reserve Corps of the Public Health Service.
- You set up an annuity. You must use an IRS-approved distribution method with at least one annual withdrawal. You likely will need professional help to calculate payments.
- You have a Roth IRA. This form of IRA account have fewer withdrawal rules than a traditional IRA. You can probably withdraw contributions (but not earnings) from a Roth IRA that is at least five years old. Some other distinguishing features of a Roth: you typically won’t owe income tax on distributions, nor are you required to take distributions starting at age 72.
- You inherit an IRA. If you inherit an IRA before you turn 591/2, you can take penalty-free withdrawals–but those withdrawals are taxable. There were some rule changes that took effect for inheritors of an IRA whose original owner died after Jan. 1, 2020. So it’s best to check with your financial or tax advisor if you come into one of these accounts.
- You leave your job at 55 or older. If you keep your money in a 401(k) you can make penalty-free withdrawals. But if you roll the 4019k) money into an IRA, you generally must wait until 591/2 to avoid penalties.
- You take advantage of the Rule of 72t, or Substantially Equal Payments. This little-known rule allows you to tap your retirement savings before age 591/2 without penalty–if you follow a set of strict rules and commit to a withdrawal schedule according to U.S. Tax Code guidelines. This can be a valuable step but also a very tricky one. Be sure to consult with a financial advisor before taking it and be sure that you can stick to the strict withdrawal amounts and time frames. We have experience in this process if this is a step you would like to take.
In short, there are several ways to avoid the 10% early withdrawal penalty if you wish to tap your retirement accounts before you reach 59 1/2. You just need to be very careful to follow the rules. Enlist a trusted financial advisor to help, so you can ask questions and get personalized information and guidance.