You need a quick infusion of cash, and there's plenty of it sitting in your IRA or 401K account. Should you withdraw the needed money from these retirement accounts?
Not surprisingly, there's no simple answer. Withdrawing from a retirement account might make sense depending on how old you are or what you need the money for. But in other cases, withdrawals from these accounts can derail your plans to save for a happy retirement. They might also leave you with a big financial penalty.
Before you make a withdrawal from an IRA or 401K plan, ask yourself these five questions. Your answers will tell you whether the time is right to take money from these accounts.
1. What Do You Need the Money For?
The goal of both 401K accounts and IRAs is to save money for your retirement years. If you withdraw funds before you hit retirement, you'll cut down on the money available to you after you leave the working world. When you're on a fixed income, you might truly miss those dollars. You'll also lose any interest that the money you withdrew would have generated, unless you pay it back quickly. So unless you absolutely need the money, it might be best to hold off on a withdrawal.
2. Can You Get the Money From Other Sources?
Again, you want your retirement accounts to be as full as possible when you leave the workforce. Can you find a different source for the money you're planning to withdraw? Maybe a family member can loan you the funds. Maybe a cash-out refinance on your home or a home equity loan can leave with you the money you need.
3. How Old Are You?
This is one of the bigger questions. If you withdraw money from your traditional IRA or 401K after you reach age 59-and-a-half, you'll do it penalty free, though you will still have to pay taxes on these withdrawals. The same is true for a Roth IRA, though you won't pay any taxes on most withdrawals from this kind of IRA.
But if you are under 59-and-a-half, you'll be hit with a 10% penalty on the money you withdraw unless you are using it for specific reasons, such as buying a first home. For traditional IRAs and 401K plans, you'll also have to pay taxes on the money you withdraw, so this move is an especially big hit. The better choice? Wait to withdraw money from your retirement accounts until you hit 59-and-a-half.
4. Will You Face a Penalty If You Don't Make Withdrawals?
You'll get hit with a penalty if you withdraw money from a traditional IRA before 59-and-a-half. But did you know you'll face an even greater penalty if you don't take regular withdrawals from your traditional IRA after you turn 70-and-a-half?
That is the age at which the owners of traditional IRAs are required to begin their minimum required distributions. If you fail to make these scheduled withdrawals you will be taxed at a rate of 50% of the distribution you were required to have made. So don't skip these withdrawals.
5. Are You Buying a New Home?
You can withdraw from your traditional IRA and Roth IRA before 59-and-a-half without any penalty if you are using the funds to buy a first home. And the definition of what makes for a first home is quite broad: Yes, a first home can be the first home that you have ever purchased. But you will also qualify for a first-home exemption if you or your buying partner haven't owned a principal residence in the last two years.
With a traditional IRA, you can only withdraw up to $10,000 to help cover the purchase of a new home. With a Roth IRA, you might be able to withdraw a bit more because you can always withdraw your contributions to a Roth IRA without facing any taxes or penalties. The $10,000 limit, though, does hold for the earnings you've made on your Roth IRA.
If you and your spouse or partner are buying a home together, you can both qualify for the first-time homebuyer exemption and borrow $10,000 each, giving you $20,000 to use toward your home purchase.
Remember, though, you are still losing this money from your retirement account. You might enjoy that house you are buying, but you might miss that $10,000 when you hit retirement age.
The rules are different for a 401K plan, which has no penalty exemption for withdrawing money before 59-and-a-half for buying a first home. You can take out a loan against your 401K, though, and use that money to help buy a home. But you will have to pay this loan back in installments and with interest.