How to Use IRS Rules and Get Retirement Money Right Now
It’s important to save for retirement and the tax benefits are great, but what if you need money now? If you need to spend your retirement savings, there are many ways to do it. But all the specific rules confuse him.
To make it easier, here is a list of options for early withdrawal of money. Along with these options, there are all the terms and conditions you need to keep in mind.
Generally, you cannot (and should not, if you can help) withdraw money from your retirement account until you are 59½ years old. If you do so, you will be subject to early withdrawal tax, which is 10% of the amount withdrawn (yikes). There are exceptions to this rule and we will point out when they apply. (There is also an umbrella exemption for active military service, and you can read about that here .)
Take a loan from your 401 (k)
If you have a 401 (k) or 403 (b) and need money now, most employer-sponsored plans will allow you to borrow funds from an account. You will have to return this money, but you still have to do it. You want to replenish your nest egg, no matter how you borrow money from it.
There are limits, of course. You can borrow up to $ 50,000 or 50% of your account balance, whichever is less. You will have five years to get your money back with interest. Of course, this money, including interest, goes back into your retirement account. In fact, calling it “interest” is a bit misleading, because the money is returned to you anyway.
Since this is a loan, the money you borrow is tax-free. However, you will be taxed on interest – twice. First, you already pay interest with your dollars after taxes. Second, since the interest is returned to your account, you will also be taxed when you withdraw it when you retire. Basically, you are taxed on your money after taxes.
Also, suppose you borrow money and without paying it back, you lose your job. According to Forbes , your former employer is likely to want you to get that money back quickly. And if you don’t, they may view your outstanding balance as an early distribution and you will have to pay fines.
Accept hard rejection
But if you think that money will be tight and you are having trouble repaying your loan, you might consider using the hardship exception available for most 401 (k) s. The IRS states that there must be an “immediate and serious” need for your situation to be considered dire. Here’s what that means, according to their website :
Some costs are considered immediate and large, including: (1) certain medical costs; (2) costs associated with the purchase of a primary residence; (3) tuition fees and related educational costs and expenses; (4) payments necessary to prevent eviction or foreclosure of the foreclosure of the main dwelling; (5) expenses for burial or funeral; and (6) certain costs of repairing damage to the worker’s primary residence. The cost of buying a boat or a TV is usually not apportionable in difficult conditions. A financial need can be immediate and serious, even if it was reasonably foreseeable or voluntarily incurred by the employee.
If you have an employer sponsored account, your employer should not allow this, but most do. But here’s the catch. Depending on the difficulty, you may have to pay a 10% early withdrawal tax or penalty on the amount you withdraw . For example, you can withdraw money for education expenses but pay a fine. For this reason, a 401 (k) loan is usually the best option.
The IRS has a handy chart that tells you which scenarios are exempt from this penalty, depending on what the difficulty is and depending on the type of retirement account.
These hardship royalties also apply to the IRA. And the IRA has more options without fines.
Withdraw your contributions to the Roth IRA
If you have a Roth IRA, you have already paid your premium taxes. We explain this in more detail here , but it works like this because it is not a tax-deferred invoice. Unlike a 401 (k) or traditional IRA, you cannot deduct the money you saved in a Roth IRA from your taxable income. You pay taxes on this.
Because of this, you can withdraw these contributions at any time and for any reason from the Roth IRA. You’ve already paid your taxes, so the IRS doesn’t care. Withdrawals are also carried out without penalties.
The key word here is deposits . Ideally, the money in your IRA grows. You cannot make a profit without a penalty, but only the original amount that was actually deposited (also known as the principal ). So you have to prove how much you have contributed over the years. You can get this proof from the company that has your account.
Aside from this evergreen rule for Roth accounts, there are a few specific cases that allow you to withdraw IRA money without penalty.
Use an education exception
You can get IRA money without penalty if it is used to educate you, your spouse, or your children or grandchildren. This works for any type of IRA and is not limited to contributions. You can also withdraw earnings.
Of course there are rules. The IRS is pretty straightforward about what counts as education spending:
… these expenses include tuition, fees, books, supplies and equipment required to enroll or attend a suitable educational institution. They also include the costs of special needs services incurred by or for special needs students in connection with their enrollment or attendance. In addition, if the student is at least part-time, room and board are eligible education expenses.
Moreover, the institution must also be approved by the IRS. This likely won’t be a problem: it includes “all accredited government, non-profit, and private (private for-profit) institutions after secondary education,” according to the IRS.
Any money you withdraw from your account will be taxed if not already deposited. This is true for any of these scenarios.
Use the First Home Exception
Buying your first home? You can take $ 10,000 from your IRA to help cover costs. If you are married and you and your spouse are buying a home for the first time, you can both opt out of your IRAs. This gives you $ 20,000 to invest in your first home. The rule is pretty flexible too. You don’t have to buy your very first home, just your very first “main residence”. If you have never owned a primary residence in the previous two years, you may qualify for this right. This means that if you bought a vacation home somewhere, you can still qualify for this exemption. And you can also use an exception to help a child, grandchild, or parent.
There are several conditions. You must use the money within 120 days from the date of withdrawal. You can only use it for mainstream residential properties, and it can be used for any expense related to buying, building, refurbishing, financing, or closing.
Of course, this is a withdrawal, so if you have a traditional IRA, you will be taxed on the amount you withdraw. And there are special rules for the IRA Roth too.
Special rules for Roth
Once again, you have already paid taxes on your contributions to Roth. So it may seem like you don’t have to worry about tax bills for home buying money. But when you open your mouth it matters.
If you have owned a Roth account for more than five years, this is a qualified allocation and you don’t have to worry about being taxed except for the first home.
But if you opened your Roth IRA less than five years ago, the takeaway is early spread . Thus, while your contributions are not taxed, you could be taxed on any income you withdraw. Bankrate explains how to get around this:
You can reduce your tax costs by first deducting taxable contributions from your Roth. In fact, the IRS has certain rules about the order in which you can take unqualified Roth distributions: contributions, conversions from traditional IRAs, and earnings.
In general, withdraw your dues and you will be fine. If you need more, you can withdraw your earnings, but you are taxed.
“Give Back” Your IRA Contribution
Let’s say you save a lot. You’re saving so much that you’ve actually saved a little more in the IRA than you wanted, and now you’re running out of money.
The IRS offers a so-called “chargeback”. You can return one contribution to your Traditional IRA without having to pay tax on it. You will need to do this before you file your tax return for this year, and of course, you cannot defer this contribution from your income. In the end, you take it back.
If you are stranded and have a traditional IRA, this is something to consider. Zach has more details on this , including step-by-step instructions on how to do it.
Borrow money from rollover
Here’s a somewhat risky IRA workaround if you need a little more money. You can transfer your traditional IRA to a Roth IRA and then borrow that money. The rollover must be completed within 60 days, but during this time you will have access to the money. If you think you can return it within 60 days, this might be the option for you. But if you do not return the money, you will face a fine.
Bankrate indicates that this is not a revolving loan. Thus, you cannot cheat the system by returning money back to your traditional IRA and then initiating another transfer. According to the IRS :
Generally, if you make a tax-free rollover of any portion of an allocation from a traditional IRA, you cannot make a tax-free rollover of any later allocation from the same IRA for one year. You may also not be able to carry out a tax-free renewal of any amount allocated during the same one year period from the IRA into which you made the duty-free renewal.
This may be obvious, but worth noting.
Take “nearly equal recurring payments.”
A lesser known option, according to Forbes , is recurring payments of almost the same size . They say the catch is that you have to keep getting these benefits for five years or until you reach 59½, whichever comes later. They offer several ways to calculate payouts:
In the simplest case, which yields the lowest annual payment, you divide the total IRA cost by your remaining life expectancy. Claudia Hill, president of Tax Mam from Cupertino, California, and a Forbes contributor, recommends working in the opposite direction. First, figure out how much money you need, and then calculate how much IRA this annual allocation will produce. Then, divide your IRA into one slice that contains exactly the amount you need to get your desired annual payout. Later, if you need even more money up to 59 1/2, you can get it from the second account without jeopardizing the distribution without penalties from the first.
Again, you will have to pay taxes on any money that has not yet been taxed.
Taking money out of retirement is not an easy decision. There are so many factors to weigh and take into account. For example, depending on the type of account, withdrawing money may increase your adjusted gross income, which may affect your eligibility for financial assistance. Make sure you consider all the possible effects before deciding.
You also want to be sure to fund your account over time. Of course, you may need the money you’ve already saved up to buy a house, pay for your studies, or help make ends meet during tough times. Just remember, you saved that money for a reason. You don’t want to lose sight of your pension.