Tapping Your Retirement Funds for an Emergency

Written by , June 27, 2011

Tapping Your Retirement Funds for an EmergencyAs any financial advisor will tell you, it’s important to have some savings set aside just for emergencies. But what if an emergency happens before you’re able to get adequate savings together? Or what if you have an emergency fund, but your emergency turns out to be bigger than your fund is?

If you have a retirement fund, you can withdraw money from it. But this should only be done in the event of a true emergency, because it depletes your retirement savings and may expose you to tax penalties. Still, it’s good to know that those funds are available if you really need them.

Here is some advice on whether tapping your retirement funds for an emergency is a good idea.

  • There are penalties for early distribution. The minimum age for distributions from most retirement plans is 59 1/2. If you withdraw money before you reach that age, an early distribution penalty of 10% will be assessed in addition to regular federal and state income taxes.
  • There are different rules for IRAs. With regular IRAs, if you withdraw money within two years of opening the account, the early distribution penalty is 25% instead of 10%. However, if you have a Roth IRA that you’ve owned for five years or more, there is no penalty for early withdrawal.
  • There are certain exceptions to early distribution penalties for IRAs. If the account is an IRA, you don’t have to pay the penalty if you become permanently or totally disabled, become unemployed and use the money to pay health insurance premiums, or use the money to buy a home, pay college expenses for yourself or your dependent or pay medical expenses in excess 7.5% of your adjusted gross income.
  • There are certain exceptions to early distribution penalties for other plans. Exceptions for 401(k) or 403(b) plan owners include distributions made when the participant dies or becomes disabled, to pay for medical expenses in excess of 7.5% of your adjusted gross income, or to satisfy a divorce or separation agreement.
  • Tax withholding options. When you make an early withdrawal, you may elect to have income tax withheld, but this is not required. However, if you do not have taxes withheld, you will have to pay them when you file your taxes. The penalty is also due when your taxes are filed.
  • Keep in mind when withdrawing money from your retirement account that your losses amount to more than just the taxes you pay. You’ll miss out on compounding interest or earnings potential of the money you’ve withdrawn. Even if you ramp up your contributions later on to compensate, you’ll still lose out on the money you would have earned until you make up the amount.
  • It’s crucial to carefully consider all other options before you withdraw money from a retirement account. But in some cases, that may be the only viable option. Knowing the costs before you make a withdrawal will help you make a good decision.

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