Think Twice About Tapping Your Retirement Fund

If you’re behind on your bills or need extra cash, the money in your retirement account may start to look pretty tempting. But before you make a withdrawal, consider the alternatives, and understand what penalties you face if you take money out before retirement.

Know Your Other Options

Before pulling from your retirement savings, take a close look at your finances and your other financial options. Do you know where your money is going? Could you find the money you need by slashing expenses and plugging spending leaks in your budget? Can you use the money you’ve set aside in a savings account for an emergency or find an alternative borrowing option?

Avoid Penalties

As a general rule, if you are younger than 59½ and you withdraw money from a retirement account, you will pay a 10 percent early withdrawal penalty, and the amount you withdraw will be considered taxable income.

To minimize penalties:

• Make small withdrawals. The penalty only applies to income actually withdrawn. So rather than cash out your entire account in any one year, take the minimum amount you need to make ends meet. That leaves the rest of your retirement savings to keep growing on a tax-deferred basis. And you can always take a second or third withdrawal.
• Return the money in 60 days. You can withdraw funds from an IRA without taxes or penalty if you return the funds to a different IRA by the end of the 60-day period.
• Take it all in substantially equal payments. With IRAs, substantially equal payments means you withdraw roughly the same dollar amount per year for five years or until you reach age 59 ½, whichever takes longer.

Exceptions to the Rule

If you are 55 or older and either quit your job or are laid off, and you’ve been participating in a qualified retirement plan, such as a 401(k) or a pension plan, the 10 percent early withdrawal penalty does not apply. Just keep in mind that any amount withdrawn still will be taxable as ordinary income.

If you are under age 55 and have money in a Roth IRA, you can withdraw amounts up to the total contributions that you’ve made over the years if necessary without penalty, because your Roth IRA contributions went into the account after tax. Just be sure not to withdraw any earnings, because those may be taxable and subject to the 10 percent early withdrawal penalty, depending on your circumstances.

While taking money out of your retirement account can look appealing during an emergency, think of alternatives first. With a go-to emergency fund and a smart budget,  you can avoid even having to consider dipping into your long-term savings.