I've heard many people say: "I would invest in my retirement account, but then I can't touch that money until I'm 59.5 years old." Besides the obvious objection that there is merit in setting money aside for the future, the age limit should not be the reason why you’re missing out on tax-free investment growth. There are multiple ways to get that money before the required age without paying the 10% penalty. If you think you're going to need it early, a little planning is usually all it takes. Let's go through some options.
Roth Contributions are Withdraw-able
This seems to not be widely known, even though it is one of the top benefits of a Roth account. Since you already paid income tax on the contributions to your Roth accounts, you are allowed to withdraw that money at any time, penalty free. This only applies to your contributions (the money you put it) and not on any earnings that have accrued in the account.
The Roth IRA is slightly different (better) from other accounts like the Roth 401(k) in this regard. Withdrawals from a Roth IRA will always be contributions first before removing any earnings.
For the Roth 401(k), it is subject to the "cream on the coffee" rule. Each withdrawal will be counted as a percentage of contributions and earnings. For example: if your account is $60,000 in contributions and $20,000 in earnings for a total of $80,000, then your account is made of 75% contributions and 25% earnings. Each dollar amount you withdraw from your Roth 401(k) will then be counted as 75% contributions (tax & penalty free) and 25% earnings (will be income taxed and subject to 10% penalty). You can see for this reason that the Roth IRA is the better account. The good news here is that once you have terminated service with the administrating employer, you can roll your Roth 401(k) into your Roth IRA and these problems all go away. Below is a comparison to illustrate the difference when taking early withdrawals from each account.
The Rule of 55
The Rule of 55 says that if you're laid off, fired, or quit your job between the ages of 55 and 59.5, you may withdraw from your 401(k) or 403(b) plan without penalty. This applies if you leave your job any time during or after the calendar year of your 55th birthday, so you could be 54 as long as you're turning 55 that year.
This only applies to the 401(k) at your current job and not to balances still in 401(k)s with previous jobs. You can solve this rather quickly, though, by rolling your other 401(k)s into you current one before you quit.
Substantially Equal Periodic Payments (SEPP) - 72(t) Distribution
With Substantially Equal Periodic Payments, you can withdraw money from your IRA or 401(k) at any age as long as you no longer work for the employer administering the plan. The payments will be calculated based on your life expectancy, and will be payed out for at least 5 years or until you hit 59.5, whichever is later. This strategy takes a lot of planning to make sure it's the right decision for you.
IRA Distributions for Tuition
There is no penalty for withdrawing from your IRA for qualified higher education expenses including tuition, administrative fees, books, and supplies including laptops and notebooks. If the student is more than half time, room and board can also qualify.
IRA Distributions to Buy a House
If it's been more than 2 years since you have owned a "principal dwelling" (the house you live in, not an investment property or vacation home), you qualify for $10,000 of "first-time home buyer" IRA distributions. This applies not only to you, but also to a direct family member who you may be helping to buy a house. The $10,000 limit is strict with your traditional IRA, but remember you can withdraw contributions from your Roth IRA anytime you want, so the $10,000 limit only applies to early withdrawals on the earnings.
Roth Conversion Ladder
This is an early retirement and tax-avoidance strategy. It’s based on 2 facts:
Roth contributions are able to be withdrawn at any time, penalty free
Conversions count as contributions after 5 years.
It can get a little complicated to do it tax efficiently, but the gist of it is to convert portions of your tax-deferred accounts to your Roth IRA (you would do this in relatively small amounts each year because it's a taxable event), and then 5 years after the conversion, that money will count as a Roth contribution and therefore will be withdraw-able at any time. It's a "ladder" because you would do a conversion each year, and once 5 years hits, you would have a new amount of money available for withdrawal each year.
This strategy takes planning. If you’d like to learn more about it, read my in-depth walk through of how to perform it.
457(b)
If you're a public employee (mainly a teacher, firefighter, or police officer), you may have access to a 457(b). This is a wonderful account with multiple advantages over a 401(k), but the one that fits here is its early withdrawal rules.
Once you have terminated service with your employer, the funds are immediately available penalty-free. So whether you're fired, take a couple years off to take care of a new child, or just straight up quit, that money is available immediately, no matter your age. This is a favorite account for early-retirees.
Hardship Withdrawals
If you qualify for an "immediate and heavy financial need", then you may be eligible for qualified distributions as a "hardship withdrawal." This option should be a last resort, and it's also pretty hard to qualify; they are mostly for medical expenses that well exceed your income. But if it is a true emergency, it might be worth it.
Final Thoughts
I'm certainly not suggesting that you make withdrawals from your retirement accounts. There's a yearly limit on contributions for a reason--you're saving a ton on taxes. You should take as much advantage of these accounts as possible. But if you're not using them because you think that the money is stuck, please consider the options available to you. And before you take any action to withdraw, please make sure you have a plan and understand if you qualify fully and what the implications of the move are.
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