Never withdraw from your IRA. There are a lot of good reasons not to do so, including penalties if you’re under 59 1/2 years old. There are also times when the expression “rules are made to be broken” applies. Why shouldn’t you withdraw? What are the advantages and disadvantages? And when should you disregard the advice to never withdraw from your IRA?
Penalties and Taxes on Withdrawing From Your IRA Early
Accessing the income you’ve set aside for the future might seem like a good idea during major life changes, like if your spouse gets laid off, you’re behind on a mortgage, or you’re facing high medical bills. However, it’s probably not. The IRS charges 10% in penalties on every withdrawal and your state will also penalize you. There are some very specific exceptions to the penalty for withdrawing early. These include:
-Paying for college costs for yourself, your spouse, your child or your grandchild
-Covering medical expenses that exceed 10% of your Adjusted Gross Income
-Covering health care premiums during a period of at least 12 weeks of consecutive unemployment
-You’re a first-time home buyer, purchasing for yourself, your child or grandchild
However, even though you’re waived from the penalties, you will still have to pay taxes on the money withdrawn, and the extra funds are likely to put you in a higher tax bracket.
Let’s say you go ahead and withdraw, anyway. You pay the penalty. Unless it’s a Roth IRA, you also have to pay income taxes on the money you withdrew. And, just to make sure you can pay it, the funds administrator will withhold an automatic 20%. After you’ve paid your taxes you can get the difference back – if anything is left. It’s more likely you’ll have to pay more than the 20% that was withheld, which you’re also paying taxes on.
When it comes down to it, you’ll end up paying about 50% in taxes and penalties. What’s even the point of withdrawing?
Don’t Withdraw: Protect Your Future
There’s another reason to never withdraw from your IRA.
It seems trite, but it’s the reason you have the IRA in the first place, so some day in the future you can enjoy your retirement without having to get a part-time job as a greeter at Wal-Mart or applying for a title loan. So you can relax. So you can do the things you want to do, like travel. More than that, you’re working hard now so you don’t have to later.
Regaining those savings isn’t easy. The sooner you start, the more you have. We all know that. And if you’re lucky, your employer is matching your contributions, even if they’re not matching you dollar for dollar. But if you empty out your retirement fund, you have to start from scratch.
Let’s take a look at that very briefly. According to the traditional IRA calculator at Bankrate.com, if you start contributing the maximum $5,500 (as of 2015) to your account at age 25 and plan to retire at age 65, by the time you retire you’ll have $1.2 million in your IRA (assuming a 7% rate of return). After taxes, you’ll still have over $1 million.
Now let’s say you clean out your IRA and at age 40 begin contributing again. That’s more than half the time, so you should have about half the money, right? Not so. Again making the maximum contributions, you’ll have about $400,000 altogether and only about $340,000 after taxes. Ouch.
Bottom line: There are many other ways to cover the unexpected, from home equity loans to personal loans. If you have other investments, those should go first, as well.
When Should You Break the Golden Rule?
It’s easy to say “never”, but the truth is there are exceptions for almost every rule. Never withdrawing from your IRA is no exception.
Basically, if you’ve weighed your options and can’t come up with anything else, it could be worth it to you, as long as you know what you’re getting into and the short and long-term effects will be.
There are other exceptions, too. For instance, if you want the money to start your own business, or open a restaurant, or a bar, you could cash in your IRA, knowing that you’ll pay penalties and fees, in order to fund it or partially fund it. There are risks: you could lose everything. But you might end up with more than you had.
When it comes down to it, withdrawing from your IRA is a bad idea. It can create a series of short-term and long-term financial issues that could be hard, or impossible, to come back from. However, if you decide to move forward with it anyway, be sure you know the risks and talk to a financial advisor about other possible solutions, first.