While you may be planning to keep funds stashed away in your retirement accounts until you’re financially ready to leave your job, life can throw curve balls. If you find yourself short on cash before retirement, one way to support your household could be to take an early withdrawal from your individual retirement account. However, taking money out of an IRA early can have significant financial consequences. An early IRA withdrawal can trigger penalties and taxes.
Here’s what to consider before taking an IRA early withdrawal:
— There’s a 10% IRA early withdrawal penalty.
— There are several exceptions to the early withdrawal penalty if you use the money for specific purposes.
— You need to pay income tax on an IRA early withdrawal.
— There could be better ways to pay for an unexpected expense.
Here is a breakdown of what to expect when taking an early withdrawal from your IRA.
What Is an IRA Early Withdrawal?
An IRA is set up with retirement and long-term savings in mind. When you make contributions to an IRA, the funds can be placed in investments where they have the chance to generate earnings over time. When you reach age 59 1/2, you are allowed to take withdrawals from the account without any penalties. If you take out funds before you are at least 59 1/2 years old, the action is considered an “early withdrawal.” After age 72 you need to take required minimum distributions from the account.
IRA Early Withdrawal Penalty
If you take funds out of an IRA before you reach age 59 1/2, you can expect certain financial repercussions. “You will be charged a 10% penalty on the funds withdrawn,” says Colton Castleman, a retirement counselor at Assurance & Guarantee in Burlington, North Carolina. “This amount will be taken from the amount withdrawn.” If you take out $10,000, you can expect the penalty to be 10% of that amount, or $1,000.
The penalty means you’ll have to take out more than you need to cover an expense. For instance, if you have a bill that is $10,000, you’ll have to take out more than $10,000 to cover the penalty that will be incurred and still have enough for the payment.
Tax Implications of an IRA Early Withdrawal
When you withdraw funds from your IRA, the amount will be considered part of your income for the year. This means that the amount will be subject to income taxes. If you are in the 24% tax bracket and you take out $20,000, the taxes for the withdrawal could be $4,800 (24% of $20,000). With that in mind, you will need to take out enough to cover the taxes you will owe on the withdrawal and still pay for the expenses you’re facing.
Avoiding the IRA Early Withdrawal Penalty
When you retrieve funds before age 59 1/2, there are several instances in which the usual penalty may be waived. For example, you could set up a series of regular withdrawals from the account that won’t trigger the early withdrawal penalty.
You generally won’t need to pay the IRA early withdrawal penalty if you use the money for:
— Medical expenses that exceed 10% of your adjusted gross income.
— Health insurance premiums while unemployed.
— Costs associated with buying a first home, typically up to $10,000.
— College tuition and other higher education costs.
— The birth or adoption of a child, up to $5,000.
— A severe disability.
While you may be able to avoid the early withdrawal penalty, you will still owe income tax on the distribution. “These types of withdrawals are still considered gross taxable income, but no penalty is imposed and it’s not required for you to pay it back,” Castleman says.
Considerations Before Taking an IRA Early Withdrawal
Since IRAs are designed for long-term savings, there are typically implications with an early withdrawal. “There are few benefits to early withdrawals, unless you have a hardship or other immediate need resulting in your needing the money,” says Rob Williams, vice president of financial planning, retirement income and wealth management at the Schwab Center for Financial Research.
You may consider other ways to cover unexpected expenses, such as a loan or budget adjustment. In the case of an emergency, it may be necessary to take an early withdrawal, which could include a waived penalty if you’re eligible. “Though the flexibility has its benefits, it’s important to remember that your IRA savings are meant to benefit you in the long run and withdrawing early can minimize the potential gains on your earnings,” Williams says.
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What Happens When You Take an IRA Early Withdrawal originally appeared on usnews.com