Don’t touch that money!

April, 09 2014 by Carol Thompson, EA

Under 59½? Need some extra cash? Don’t use your retirement! It isn’t a savings account or a piggy bank to be used to buy an extra pizza on Saturday night. You could pay up to half or more of the withdrawal in tax and penalties. What you need to know:

1. If you are under 59 ½, you might have to pay a 10% federal penalty plus regular income tax. (Also be sure to check your state’s rules for penalty costs.) Download IRS Publication 590, Individual Retirement Arrangements (IRAs) or Publication 560, Retirement Plans for Small Business before you take the money.
2. There are a few exemptions allowed to skip the penalty, but not the income tax:
   • Distributions from an IRA to a beneficiary after the death of the account owner.
   • Disability (yours) – must be documented. Have a note from your doctor in your records.
   • Periodic distributions based on your life expectancy.
   • Qualified first-time homebuyer distributions up to $10,000 to pay for buying or building home.
   • An amount that is not greater than the adjusted qualified education expenses. (See IRS Publication 970, Tax Benefits for Education, Chapter 9.)
   • The cost of health insurance while you are unemployed longer than 12 consecutive weeks.
   • An amount that is not more than the total unreimbursed medical expenses less the adjusted gross income limitation if you itemize your deductions (10% of AGI, 7.5% if you were born before January 2, 1949).
   • The IRS levied the account.
   • You are a military reservist who:
     • Was called up for more than 179 days or indefinitely.
     • Was on active duty.
     • Funds may come from your IRA, 401(k) or 403(b), or other pension plan  

Keep in mind some of these exemptions are allowed for just IRAs, and some for just pension plans, and some for both.3. “But, the financial institution already took the taxes out!” No, they withheld taxes, like payroll, usually between 10% and 20%. You still have to add the distribution to other income, which can result in a higher bracket, and then must calculate any penalty due.

Example: You are buying your first house and decide to take $20,000 out of your IRA for the down payment. The entire $20,000 is subject to regular income tax; let’s say 25% Federal, and 8% state. $10,000 is subject to the penalties, 10% for the IRS and say, and 2% for your state. That’s 39% of the distribution, or $7,800 in additional taxes. Your net additional down payment is $12,200.

The moral of the story is to leave retirement alone except for true emergencies. It is costly to take it before you are “of age” and it is more important as you get older.