Withdrawing money from retirement accounts

Withdrawing money from retirement accounts

Now that we've covered how to put money into your retirement account, and how to manage it once it's in there, let's take a look at how to withdraw your money.

The government gives up a lot of tax revenue by letting you save through retirement accounts. The government is offering you the carrot of tax deferred savings, but it also has the stick of penalties to deter you from raiding your account before retirement.

Penalties for early withdrawal

Generally, you cannot withdraw money in retirement accounts until you reach the age of 59.5. If you withdraw funds early, the amount you withdraw is treated as taxable income with taxes due immediately. You also must pay an additional penalty tax of 10 percent of the amount withdrawn.

As always, however, there are exceptions and you actually have a good degree of access to your money.

Borrowing against retirement account assets

In the case of a 401(k), it depends on the plan, but you generally can borrow against your account balance for any reason. You don't have to show any kind of hardship. You normally can borrow up to half of your account balance, up to a maximum of $50,000.

The term of the loan is normally five years, and longer if the loan is used to make a downpayment on a home. You generally pay a low interest rate on the loan, and best of all, you usually pay the interest to your own retirement account.

403(b) plans also normally allow borrowing against your account. IRA's are different, however. You can't use your IRA money as collateral for a loan.

401(k) hardship cases with penalty

401(k) plans also allow you to withdraw your money in so-called hardship cases. The definition of a hardship varies from plan to plan, but some acceptable hardships include making a downpayment on a home and paying for college tuition.

In these cases you can withdraw your funds before age 59.5, but you still must pay the penalty tax of 10 percent, despite the hardship.

401(k) hardship cases without penalty

There are also cases where you can withdraw money from your plan without paying the penalty tax, but these are more drastic cases. If you have large uninsured medical expenses or suffer a disability and cannot work, you can withdraw the money before age 59.5 and avoid paying the 10 percent penalty tax.

Also, if you die before age 59.5, your beneficiaries can withdraw the money without paying the penalty. In both cases, however, regular income taxes must be paid.

Withdrawing money as an annuity

Finally, you can withdraw money before age 59.5 and avoid any penalty if you agree to withdraw the money in a series of roughly equal payments each year.

Assume you're 50 and have enough money saved up to retire. You can stop working and receive roughly equal annual payments from your account as determined by IRS tables.

You must continue these payments for five years or until age 59.5, whichever is later. You must pay normal income taxes on the annual distributions, but you won't have to pay a penalty.

Withdrawing money after age 59.5

We've talked about how to manage money before you've retired, so now let's look at how to manage and withdraw money from your accounts after retirement.

After age 59.5 you can tap into your accounts without penalty, but your retirement accounts should be the last place you'll want to look for money.

If you have other savings outside of retirement accounts, you'll want to use these other savings first. You'll want to let your money in the retirement accounts grow tax-deferred as long as possible.

Forced withdrawals after age 70.5

However, the day will come when you'll have to begin to withdraw money from your retirement accounts. In fact, after you reach age 70.5 you must begin making minimum withdrawals from your retirement accounts according to a set schedule. Unfortunately, you can't let the money grow tax deferred forever.

But in most cases when you take the money out after age 59.5, you can take out almost any amount you want, whenever you want. You can take out a big chunk all at once, or you can have your mutual fund send you checks on a monthly basis. If you receive a lump sum from a pension, you can annuitize the lump sum by turning it into a stream of monthly payments for your lifetime.

However, you will have to pay income taxes on almost all the distributions that you receive from your retirement accounts. About the only exceptions are if you make non-deductible contributions to your IRA or 401(k).

At the end of the year your old employer or the mutual fund will send you a Form 1099-R. This form shows how much you received from your retirement account. The IRS uses this information to ensure that the amount listed on your tax return matches the amount distributed by your mutual fund.

And if you have a large retirement account with more than, say, $200,000 in it, you may want to consult with a tax expert regarding withdrawals and ultimate distribution of the account. If you're not careful, you, your estate, or your beneficiaries can pay income and penalty taxes totaling 50 percent or more if you let too much money accumulate in the account.