The short answer is, it is generally not recommended but there are a couple situations where pulling early from retirement accounts is an option and could be helpful.
A common question I see often is should I take money out of my retirement accounts before retirement age?
In this article I will break down the Pros and Cons of pulling money out of your retirement accounts early, provide a brief summary of the exceptions to the 10% penalty, as well as my thoughts on taking an early distribution:
First things first, I want to be clear in that both 401(k) and IRA accounts are designed to be long-term savings vehicles for retirement. It is generally recommended that you do NOT pull money from these accounts before the retirement age of 59 1/2 (as of 2023). Pulling money before that age will cost you a penalty of 10% of the amount withdrawn. This will apply to both Roth and Traditional accounts. For a more detailed explanation of Roth and Traditional accounts check out the article here.
However, there may be times when you need to withdraw money from these accounts before you reach that retirement age. In this blog post, we will discuss the pros and cons of taking an early withdrawal from a 401k or IRA and the penalties associated with it.
Pros:
Early withdrawals from 401k and IRA accounts can provide access to funds in case of financial emergencies, such as medical expenses or job loss.
There are exceptions to the 10% penalty, such as buying a first home or paying for college education (see below).
In some cases, taking an early withdrawal from a 401k or IRA can help you avoid other types of debt, such as credit card debt, which may have higher interest rates.
Cons:
The main disadvantage of taking an early withdrawal from a 401k or IRA is that you will have to pay a 10% penalty on top of your regular income tax. This can add up to a significant amount of money and eat into your savings.
Taking an early withdrawal can also lower the overall balance of your retirement account, which can negatively impact your long-term retirement savings.
Additionally, withdrawing money from these accounts before you reach retirement age can also limit the amount of time that the money has to grow and compound.
Exceptions to the 10% penalty:
It's important to note that there are some exceptions to the 10% penalty:
- First Time Home Purchase
- Reservist Distributions
- Education Expenses
- 72(t) Payments
- Inherited the Retirement Account
- Health Insurance
- Disability
- Medical Expenses
However, these exceptions are narrow, and you should always consult a financial advisor or a tax expert before doing so. For a more detailed explanation of the exceptions The Balance did a great article on this here: Exceptions to the IRA Early-Withdrawal Penalty (thebalancemoney.com)
Conclusion:
In conclusion, taking an early withdrawal from a 401k or IRA should be a last resort. The penalties and long-term impact on your retirement savings can be significant. It's important to consider all of your options, such as budgeting, cutting expenses, and finding ways to increase your income, before making a decision to withdraw money from your retirement accounts. If you do decide to take an early withdrawal, make sure to consult a financial advisor and consider the tax implications and penalties.