Frequently Asked Questions
If you own a retirement account, you have taken an important step toward securing your future. But with all the rules and regulations for different types of accounts, cashing out retirement funds can be confusing. Different standards apply to a traditional IRA, Roth IRA, or 401(k) account. Understanding how to manage your withdrawals can save you a lot of money.
When Can I Cash Out Without a Penalty?
For a 401(k) account or a traditional IRA, you can begin cashing out without a penalty at age 59 1/2. Before that, you will be hit with a 10% early withdrawal fee and be taxed on the distribution, unless you fit into one of the exceptions:
- First-time home purchase
- Qualified educational expenses
- Death or disability
- Unreimbursed medical expenses
- Health insurance while you are unemployed
Withdrawing from a Roth IRA is different. If you have held your Roth IRA for less than five years, you have to pay a 10% penalty on any earnings (as opposed to principal) you withdraw. Further, if you withdraw before you turn 59 1/2, you will have to pay income tax on any earnings in your account. If you only withdraw part of the principal, though, or if you wait both until you turn 59 1/2 and until you have held the account for five years, neither the penalty nor the tax withholding would apply.
When Do I Have to Cash Out?
Generally, you must begin cashing out retirement funds on the following April 1 after you turn 70 1/2. The penalties are steep if you fail to do so; you pay a 50% penalty on a 401(k) or traditional IRA on any part of your required minimum distribution for any year you fail to take it out.
Roth IRAs again differ from other retirement accounts here. There are no required minimum distributions from a Roth IRA, so you can continue to let the funds build without penalty.
Why Are Roth IRAs Treated Differently?
Different retirement accounts provide different tax advantages to account holders, and these result in different penalties and treatment. Roth IRAs hold funds on which you have already paid taxes, so only the earnings on the account grow tax-free. Traditional IRAs and 401(k) accounts hold pre-tax dollars, so the longer these are open, the longer you avoid taxes on what you invest.
When cashing out retirement funds, the traditional IRA and 401(k) accounts finally pay taxes on the amount of your distributions. The IRS does not allow you to avoid those taxes indefinitely, and therefore penalizes you if you try to go longer than the law intends for those accounts.
What Might Cashing Out Cost Me?
Cashing out retirement funds early can cost you a great deal. Besides the penalties and taxes you pay, or even if you take an early distribution under an exception to the penalty, you lose potentially years of earnings that the money can gain for you when you leave it in place. Depending on your rate of return, you can cost yourself thousands of dollars or more if you take your money out early.
Cashing out retirement funds too early or too late will cost you significantly. While true emergencies can justify early withdrawals, you should avoid doing so when you have other ways to cover your needs.
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