Sometimes there are lean times in our lives when we need to find extra cash quickly, and a fluffy retirement account cushioned with years of savings seems like a viable option.
In fact, 25 percent of U.S. households that use 401(k)s have withdrawn their plans for nonretirement spending needs, amounting to over $70 billion in annual withdrawals, according to a research paper by HeroWallet.
Early withdrawals are usually tagged with penalties and taxes, but there are times when you actually are allowed to borrow without penalties.
[See: 7 Stocks to Buy for the Baby Boomer Retirement Wave.]
401(k)s have tighter rules. The two most common retirement plans, a 401(k) and an individual retirement account, have different withdrawal rules.
If you have a 401(k), it’s best to check with your plan’s administrator because plans have many different options, says Randi Merel, first vice president of Wealth Management and senior financial advisor at Merrill Lynch.
“For example, a 401(k) loan must be paid back within a specific time frame while still employed (usually from five to 15 years), otherwise it will be treated as a distribution, which carries a penalty and tax obligation on the unpaid balance. Understanding these nuances is critical and is another reminder why it’s important to have tax and financial advisors involved.”
Buying a home. “You are allowed a penalty-free, taxable $10,000 distribution under an IRA (loans aren’t allowed under IRAs) and a penalty-free and tax-free loan under a 401(k),” Mercel said.
“With a 401(k), you are allowed to borrow 50 percent of the vested account balance or $50,000, whichever is less. You will be required to pay back the loan with interest under certain terms and conditions, but you are paying yourself back with interest and are building long-term equity in a home,” she says. “Also, if this additional down payment avoids the expense of private mortgage insurance, it has significant benefits.”
First-time home buyers can take out $10,000 and you only use $5,000 on qualified home buying expenses, and still have the other $5,000, said Dean Ferraro, enrolled agent and tax preparer. “And if you’re married, each spouse can contribute together up to $20,000 for the same purchase.”
Health insurance while jobless. There’s nothing worse than getting sick while unemployed and either being afraid to go to the doctor, or falling deeper into debt with a hefty medical bill.
“If you’re unemployed for a period of time, you can pay your health insurance with IRA money,” said Richard Stevenson, senior financial planner at Janney Montgomery Scott, a full service financial services, wealth management and investment banking firm.
Higher education. If you have to pay for college for yourself, spouse, children or grandchildren’s, you can use IRA money, Stevenson says.
“If you incur higher education expenses of any kind, you are still permitted to remove IRA money that year regardless of how it’s used,” he says.
It’s different for 401(k) plans, however. They don’t allow a penalty-free withdrawal for college, but you can use a 401(k) loan, Merel says. “You must still be employed with your company while you have an outstanding loan.”
[See: 12 Steps Toward a Strong 401(k).
Medical costs. If your medical expenses exceed 10 percent of your adjusted gross income, you can pay them from your IRA the year that you incur them.
Disabilities. “If you’re permanently disabled, you’re allowed to remove however much you need, but the IRS states that you must be unable to perform any sort of occupation,” Stevenson says.
The most common way is to set up a series of substantially equal payments — or an annuity — then that portion of the IRA would not be penalized, and you could use it every year, he says. Annuities that meet the IRS guidelines aren’t penalized, but once an IRA owner starts large and regular payments from the account, no other additions or withdrawals can be made to or from that account for five years or until the account owner reaches age 59.5 (whichever is longer), he adds.
Loans. You can take money out of an IRA for 60 days without penalty, as long as it’s returned within 60 days, says Doug Carey, chartered financial analyst and president of WealthTrace.
“This can be a big lifeline when needing a bridge loan when selling a house and buying another,” he says.
Check with your plan administrator to confirm whether yours carries this provision, but the typical 401(k) plan allows a person to borrow up to 50 percent of the money in the account, Carey says.
“One big caveat to this,” he says. “If you leave your job, you would be required to repay the loan within 60 days or else there will be taxes and penalties on the borrowed amount.”
Military. If you’re in the military reserves and get called to active duty, you can also tap your retirement account to cover costs.
But “be careful,” says Coleen Pantalone, professor of Finance at the D’Amore-McKim School of Business at Northeastern University in Boston. “In all these cases, there are specific rules and restrictions. Make sure you understand them and abide by them or you will end up paying the penalty. You must also file a form with the IRS.”
Losing interest. Emergencies happen, but keep in mind that even if you dodge the penalty fees, you’ll lose a lot of potential interest by robbing your retirement account.
“Generally speaking, investors should look toward their retirement accounts as an absolute last resort,” Stevenson says.
A saver who keeps $14,000 in their retirement accounts from age 30 through age 62 will have $152,147, assuming an average 8 percent annual return and pre-tax growth, according to Betterment.com.
[Read: 5 New 401(k) and IRA Rules for 2017.]
“Some may never recover the money they’ve taken out. But you’ve solved a problem in most cases, and that’s the good news even though the money is gone,” says Brett Anderson, certified financial planner and president of St. Croix Advisors. “Don’t look back, look forward and update your financial plan.”
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Is It Ever OK to Rob Your Retirement Account? originally appeared on usnews.com
