Most companies, both large and small, offer their employees some form of retirement plan. Traditionally, these plans were so-called “retirement benefit” plans; employees would pay into an overall company retirement fund, and would then be rewarded with monthly pension checks, starting at retirement and lasting for life, often with survivor benefits for a surviving spouse. Many large companies, and most government agencies, still enroll their employees in such plans. Retirement pay isn’t available until regular salary payments stop.
These days, however, there are more options. More and more companies are offering their employees “defined-contribution” retirement plans, whereby employees establish their own personal retirement accounts and determine the amount of their own contributions to these accounts (or, indeed, decide not to contribute anything at all). The most common of these plans, the 401(k), has become ubiquitous. Additionally, savers can invest in Individual Retirement Accounts, or IRAs. In both cases, contributions are generally tax-deductible, and the accounts grow tax-free over the years; tax is only due on eventual withdrawals. (There are some exceptions; Roth IRAs, for instance, offer tax-free withdrawals as well, although contributions to Roth accounts are not tax-deductible.)
Because these accounts are tax-advantaged, the IRS restricts how much money you can contribute to them each year, and also places restrictions on when you can make withdrawals. When can you take money from retirement funds? That depends on the reason for withdrawal.
Generally, one can only withdraw funds from a 401(k) account penalty-free when one is 59½ years of age or older. It’s possible to withdraw money sooner, but withdrawals are then subject to a 10 percent early-withdrawal penalty. In some circumstances, you can withdraw funds at an earlier age without paying the 10 percent penalty — for instance, if you are at least 55 years old and leave your employer, or become disabled. You can also withdraw money from a 401(k) penalty-free if you simply transfer the money to another tax-advantaged retirement account (such as another company’s 401[k], or to an IRA account), in a process known as a rollover.
Additionally, you can make early withdrawals penalty-free in special situations, known as “hardship withdrawals.” These situations include paying college tuition for yourself, your spouse, or your child; paying emergency medical expenses; paying up to $10,000 toward the purchase of a primary residence; making payments to avoid eviction (from a rental house) or to avoid foreclosure; and paying funeral expenses for a family member. Before making a hardship withdrawal, ensure that your reason would be allowable, and ensure that you don’t spend any of your withdrawal for any other purpose. You will have to document how you spent your withdrawal to avoid the 10 percent penalty.
Because tax is not payable on a retirement account until you actually start making withdrawals, the IRS stipulates that you MUST begin making withdrawals by a certain age as well — namely, by age 70½. If you fail to begin making the minimum withdrawals at that age, then you will owe a penalty equal to 50 percent of the minimum distribution. (If you are still employed at the age of 70½, then withdrawals are not necessary.)
The same rules generally apply to IRA accounts. One major exception is the withdrawal rule for Roth IRAs. There is no stipulation that you must begin withdrawing from a Roth IRA at age 70½, or at any age. The reason is that all withdrawals from Roth IRAs are tax-free, and the IRS therefore has no interest in them.
You can withdraw money from your retirement accounts at any time, but you will pay tax on your withdrawals as well as a 10 percent penalty if the reason is disallowable. The U.S. Congress enabled the establishment of tax-advantaged retirement accounts to encourage savings among U.S. taxpayers, and millions of taxpayers have benefitted, allowing them to enjoy adequately financed and fulfilling retirement. The purpose of your retirement account is to fund your retirement. Don’t withdraw funds prematurely unless you absolutely have to.