One of the worst financial decisions a baby boomer can make is to raid a tax-deferred retirement account such as an IRA or 401(k) to pay for non-retirement expenses. I like to call these early withdrawals “retirement plan leaks” although sometimes they are more like floods!
401(k) Plan Hardship Withdrawals
An “early withdrawal” is one that occurs before the plan participant reaches age 59 and 1/2.
However, a hardship withdrawal from a 401(k) account can still trigger a 10% penalty plus taxes owed, unless you are:
- Totally disabled
- Your unpaid medical expenses exceed 7.5 percent of your adjusted gross income.
- You are required by court order to give the money to a divorced spouse, a child, or a dependent.
- You leave your job due to layoff, termination, quitting or taking early retirement) in the year you turn 55, or later.
According to a recent GAO Report, an early withdrawal or complete retirement plan cash-out of this nature at job separation is terribly damaging to your retirement future:
IRA Hardship Withdrawals
An IRA owner can make no-penalty hardship withdrawals for:
- Excessive un-reimbursed medical expenses.
- Payment of medical insurance premiums while unemployed.
- Total and permanent disability.
- Distribution of account assets to a beneficiary after you die.
- Certain qualified educational expenses.
- First time home purchases (maximum of $10,000 per purchaser)
If this is a conventional IRA, you still must pay taxes on the withdrawals.
Finally, the IRS will allow early withdrawals from an IRA without penalty based on the “substantially equal periodic payment rule.” Using this method, you must distribute the entire IRA balance using equal payments spread over your life expectancy.
The bottom line is that baby boomers should consider an early hardship withdrawal from a retirement account only as an absolute last resort.
Photo credit: The Pageman