Withdrawing From Your Retirement Account Before Age 59½ Without Paying A Penalty

If you are like most people, most of your nest egg is sitting in a retirement account, with just enough in a savings account to cover six months of emergency expenses.  

Then an unexpected event like COVID 19 happens and wipes out your emergency fund and leaves you trying to figure out where your next dollar will come from.

Retirement accounts are not intended to be used as an emergency fund, but with the pandemic and recession already lasting 5 months, many emergency funds have been depleted. We never encourage early withdrawals from retirement accounts, but sometimes it can be used as a last resort. If you lost your job and have expenses that need to be paid and have searched out every possible avenue to create cashflow and nothing has worked, then you can use your retirement plan as a last resort.

The first rule you need to know is: When you withdraw money from a  pre-tax retirement account such as a 401k, 403b, Simple IRA, SEP IRA, or IRA, you have to pay income tax on 100% of the withdrawal. This is true no matter when you withdraw the money.

The second rule is: When you withdraw money from a post-tax retirement account such as a Roth IRA, there are no income taxes due when you take a withdrawal.

The third rule is: If you withdraw money from a pre-tax or gains from a post-tax retirement account before age 59½, you’ll also have to pay a 10% penalty.

Below are five ways to withdraw money from your retirement account before age 59½ without paying the 10% penalty:

1)    Withdraw the contributions from your Roth IRA account. Since Roth contributions are made with post-tax dollars (not pre-tax), you can withdraw them at any time without a penalty or taxes due. (You will have to leave the growth in the account.) For example, if you have contributed $60,000 into your Roth and your Roth is now worth $80,000, you can withdraw $60,000 with no tax or penalty.

2)    Take a bridge loan from your IRA account for 60 days. This entails taking a withdrawal from your IRA and replacing it within 60 days. (If you do not replace it within 60 days and you are under age 59½, then it will be taxed and penalized.)  Once you put the money back, your tax return will show you took the money out and put the money back, which gives you a taxable amount of $0 and no penalty. Keep in mind that if you had taxes withheld from the distribution, you will be required to replace the money that was withheld.

3)    If you are age 55 and lost your job, you can withdraw from your current job’s 401k without paying the 10% penalty. When exercising this method, it is a common practice to rollover most of a 401k but leave enough in the 401k to fund expenses to age 59½.

4)    Separation from some public safety employee retirement plans lets you start withdrawals from your original retirement account (such as 401k, 457, pension) at age 50 without a penalty. This does not apply to NON-ERISA accounts such as Simple IRAs, SEP IRAs, and traditional IRAs. This only applies to the original retirement account.

5)    At any age you can request a 72(t). This involves setting a lump sum of retirement money aside (IRA, 401k, etc.) and agreeing to withdraw substantially-equal periodic payments over a minimum of five years or until age 59½, whichever is longer . There are rules and regulations that must be followed and the amount you can withdraw will depend on the owner’s life expectancy as calculated through IRS-approved methods.

Early withdrawals from retirement accounts can be complicated, so be sure to understand all the guidelines and consequences before taking action. To find out more about early withdrawals from retirement accounts, please contact your financial advisor.

- Gail Gill, CFP®, Worley Erhart-Graves Financial Advisors