We live in a world where stuff happens.
Air conditioners break, kids need braces, and dogs need heart worm medication.
When the unexpected occurs and you suddenly find yourself in a cash needy situation, one place that investors are tempted to raid is their Individual Retirement Accounts (IRA’s).
If you don’t have a 401k that you can borrow from, your credit cards are tapped, and your emergency fund is in need of just that -an emergency, then tapping your IRA might be the only option.
This is a last resort, especially if you haven’t reached the age of 59 1/2. Did you know, however, that there are ways that you can withdrawal your IRA without penalty?
Yes, that’s right. Uncle Sam was generous to allow you to touch your IRA under special circumstances. If you need the money for one of these reasons, then you might be in luck.
Before we continue, some words of caution. Just because you can touch your retirement money with no penalty, doesn’t mean that you don’t have to pay the tax. If you’re withdrawing money out of a Traditional IRA, you’ll have to pay ordinary income tax. There’s no way getting around that.
If you have a Roth IRA, however; you can pull your contributions at any time. The earnings have an age (59 1/2) and five year test they have to meet before you can have access to those funds penalty free. Then there’s the issue of compounding interest. If you keep taking money out of your IRA, there’s less to “compound” potentially leaving you short at retirement.
Paying Those Doctor Bills
An unexpected visit to the hospital can be a major financial blow to your nest egg. If your hospital bill is currently greater than 10% of your income, that portion that is above that will be penalty free.
Health Insurance For the Unemployed
Lost your job and down in the dumps? Further complication comes when you’re trying to figure out how you are going to pay for your health insurance. If you find yourself being recently let go and so as long as you receive unemployment for 12 consecutive weeks, then you are allowed to tap your IRA to pay for health insurance premiums for yourself and your family.
If you or someone in your family is planning on going to school, you can use your IRA money penalty free to help with the cost to include: tuition, fees, books, supplies, room and boar, and required equipment. To qualify, you (or they) must be going to school at least half-time to a college, university or a vocational school that accepts federal financial aid.
Note from me: I highly discourage using your IRA money to pay for your kids college education. It’s my belief that you need to take care of #1 (that’s you) and tapping your retirement money is a recipe for financial hazard.
If you are a first time home-buyer, you will have the option of using your IRA to live out the American dream. Each individual is allowed to pull $10,000 ($20,000 if you are married) to go towards
According to Fairmark.com, here are the requirements that you must meet:
- The purchase must be a principal residence.
- The person for whom it is a principal residence must be the owner of the IRA or a family member (within limits).
- The person for whom it is a principal residence must be a “first-time homebuyer” (generally someone who has not owned a home in the previous two years).
- The purchase must cover “qualified acquisition costs.”
- The purchase must be made within the applicable time limit.
This tax loophole can also be used to purchase a first home for a parent, child, or grandchild.
If and when someone has an accident or is diagnosed with a condition that gives them a permanent disability, it can be quite scary when it comes to paying the bills. If you have a permanent disability you can withdraw from your 401k early and get the money you need. You’ll have to provide a disability letter to your 401k custodian so that they will not hit you with the 10% penalty. You read more about 401k hardship withdrawal rules in another post.
Early Retirement Income
Another more complex strategy to try and avoid the 10% penalty is the rule of 72(t). The rule of 72(t) states that withdrawals from your 401k have to be “substantially equal periodic payments. You must use one of the three methods that the IRS has determined and then take your payment on a set schedule for a specific time period.
It is required that you take those payments for either 5 years or when you turn 59 1/2 , whichever comes later. For example, if you start taking your payments at the age of 52, then you must do so for 8 years. Someone who starts at 57, must do so till the age of 62.
Please note: Once a payment schedule is established, payments modified in any way will be subject to 10% early distribution penalty, plus interest penalty. 72(t)strategy may not always be suitable. An advisor, or a tax or legal professional, can help identify if this is the best strategy for you.
If you owe the IRS
If the Tax Man comes knocking at your door, he doesn’t care where the money comes so as long as you pay it: cash, check, or even credit card. And if it’s your IRA, you’re allowed to take money penalty free to settle your tax debt.
Military reserve members may also be eligible to take early IRA withdrawals. To qualify for the tax exemption, you must have been ordered or called to active duty after Sept. 11, 2001, for more than 179 days, and the distribution must be made during the active-duty period. The Army, Naval, Marine Corps, Air Force, and Coast Guard reserves are among the military branches whose members qualify.
Till Death Do Us Part
Death would seem to be the ultimate hardship and when an IRA account holder dies, the beneficiaries can take withdrawals from the account without paying the 10 percent penalty. However, the IRS imposes restrictions on spouses who inherit an IRA and elect to treat it as their own. They may be subject to the penalty if they take a distribution before age 59½.
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