Use Your Retirement Savings before Retirement—Without Penalties

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April 30, 2015 by Lisa Brammer

Traditionally, Individual Retirement Accounts, IRA’s, are used for retirement (no, duh) but there are times when people can pull money from these accounts before retirement without penalties from the IRS.

Don’t get me wrong, there are strict tax laws governing early distributions of traditional IRA and Roth IRA accounts. Typically, withdrawals taken before age 59½ are considered premature and doing so could put you on the hook for a 10 percent penalty along with any income tax that might be owed.

But like just about everything else, there are exceptions to the rule. There are times when good ol’ Uncle Sam will look the other way and say it’s okay to tap into these accounts.

Two of the most commonly used early distribution exceptions are: paying higher education costs and down payments for purchasing a house.

TIAA-CREF Financial Services conducts an annual survey on individual retirement accounts and American’s saving habits. 21 percent of this year’s respondents (those with an IRA and no employee-sponsored retirement plan) said they planned to use their IRA to either help pay for higher education (12 percent) or help with a down payment on a new house (9 percent).

These penalty-free withdrawals don’t come without guidelines. According to the IRS, when paying for higher education you can use the money for yourself, your spouse, your children, or grandchildren at any IRS approved school. The money can be used for tuition, fees, books, supplies; and if enrolled for enough hours, room and board.

The home buying exception is for first-time homebuyers. But if the house you want to purchase isn’t your first don’t despair, you can still qualify if you and your spouse have not owned a primary residence anytime during the previous two years.

Like paying for higher education you can also spread the money around by providing the down payment for a parent, child, or grandchild; just make sure you don’t pull the money out too soon—you must use it within 120 days of withdrawal. And if for some reason the sale falls through, make sure you put the money back right away.

Roth IRA’s work a little differently. You can still access them early for purchasing your first home, but you must have had your Roth account for at least 5 years to avoid the 10 percent early withdrawal penalty.

According to members of the military can also take early IRA distributions without penalty if: you are ordered or called to active duty after September 11, 2001; you are ordered or called to active duty for a period of more than 179 days or for an indefinite period because you are a member of a reserve unit; and the distribution is from an IRA or from an elective-deferral plan, such as a 401(k) or 403(b) plan or similar arrangement. But these early distributions cannot be taken before receiving orders or called to active duty or after active duty period ends.

There are also other circumstances when early distributions are allowed penalty-free. These are hard to face hardship situations such as (but not limited to): payment of medical insurance premiums while unemployed, payment of excessive unreimbursed medical expenses, payment for an IRS levy, or payments if you become disabled.

If you don’t want to take an early withdrawal from an IRA you might have another option—borrow from your 401(k) plan. Since it’s already your money it is usually simpler than getting a loan elsewhere and interest rates on 401(k) loans are typically lower than other rates you might be offered (depending on your plan). Plus, the interest you pay, you pay to yourself since the money goes back into your account. Normally you would not want to borrow from your 401(k) unless there is some sort of emergency. You’ll also want to feel your position within the company is secure. If you are laid off or if you leave, you usually must pay back your loan within 60 days or it will become taxable income and could also be subject to early withdrawal penalties.

Most people put money into retirement accounts intending to use them for just that, retirement. But it’s good to understand what other options exist should the need arise.

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