Access 401k & IRA Money Without the Penalty!

You’ve probably heard me talking about the tax benefits of retirement accounts like an IRA or a 401k. There are traditional and Roth versions for both and will, generally, either come with a tax benefit at contribution or at retirement. That’s because the government WANTS us to invest for our retirement so they give us tax benefits to incentivize us to do so.

But these accounts have their flaws.

One of the downsides to IRA’s and 401k’s is that your money is locked away until you’re 59 and ½. You may be able to access it, but it will come at cost. That cost is a 10% tax penalty. (and that’s just the federal penalty, you might also see a one for your state)

On top of the penalty, you may also be taxed on any distributions. Tax free distributions of contributions are possible after a 5 year holding period for the Roth IRA & 401k. Generally, withdrawals from a Traditional IRA or 401k would be taxable. This would be taxed as “ordinary income,” or the same as your wages, salaries, ordinary day to day business income, etc.

There’s no getting around the ordinary income tax, if applicable, but there are a few exceptions that would help you get around the penalty. Below a few of those exceptions including the designation of which accounts they apply to, along with the full list and details from the IRS here.

• Birth or Adoption (401k & IRA) - up up to $5,000 per child for qualified birth or adoption expenses

• Military (401k & IRA) - certain distributions to qualified military reservists called to active duty

• Disability (401k & IRA) - total and permanent disability of the participant/IRA owner

• Education (IRA) - qualified higher education expenses

• Disaster recovery distribution (401k & IRA) - up to $22,000 to qualified individuals who sustain an economic loss by reason of a federally declared disaster where they live

• Homebuyer (IRA) - qualified first-time homebuyers, up to $10,000

• Domestic abuse victim (401k & IRA) - distributions to a victim of domestic abuse by a spouse or domestic partner, up to the lesser of $10,000 or 50% of account (distributions made after 12/31/2023)

• Qualified medical expenses (401k & IRA) - amount of unreimbursed medical expenses (>7.5% AGI)

As you can see, the accounts can be restrictive in terms of when you can access your money, but you have a few options on penalty free distributions before you hit retirement age. It doesn’t make them “bad'“ accounts. They can be “good” for many things but keeping your money easily accessible is not one of those. That’s why it’s best to have a mixture of accounts, along with a mixture of asset classes, that make up your portfolio. Remember, personal finance is personal and the best thing for you to do is specific to what works for your situation and what will help you get to your goals.

I hope you learned something new today, see you next week!

-Neyra

Please remember that while I am a CPA now, I am not your CPA. Please consult a licensed professional on any financial, tax, or business decision you contemplate.