Does the ‘R’ in IRA really stand for ‘rainy-day’?

We’ve spoken a lot in this space about IRAs: traditional IRAs, Roth IRAs, backdoor IRAs and so on. And we’ve always presented these vehicles as fairly conventional, plain-vanilla places to save for your golden years. After all, IRA stands for individual retirement account.

Or does it?

There are any number of ways you can take cash out of an IRA – or other qualified plan – prior to retirement. We’re going to discuss them now, but one caveat first: Just because you can do something doesn’t mean you should. Remember, the tax benefits of retirement accounts are there to encourage saving for retirement.

Some hardships are harder than others

There’s no law that says you can’t take money out of a plan until you retire, it’s just a matter of tax treatment. If you withdraw the money prior to age 59½, it counts as regular income, plus there’s a 10% tax penalty.

That is, unless there’s what qualifies with the Internal Revenue Service as an “immediate and heavy financial need”. While there is some leeway with this definition, the IRS cautions against “[c]onsumer purchases (such as a boat or television)”. That said, there need not be a natural disaster or a health scare involved. The need could be foreseeable or even voluntary.

U.S. News & World Report offers some specific examples:

  • Unreimbursed medical expenses that exceed 10% of your adjusted gross income
  • Paying for health insurance for you or your spouse or dependents, but only if you lose your job and collect unemployment compensation for 12 consecutive weeks
  • Paying for college expenses, which are defined pretty much the same as for 529s; in this case, distributions are considered taxable income although the penalty is waived
  • Serving as a military reservist on active duty for more than 179 days; again, this is considered taxable income although no penalty is incurred
  • Buying or building a first home; for this, though, there is a ceiling of $10,000 for an individual or $20,000 for a couple
  • Being unable to keep working due to  severe physical and mental disabilities

There are other special cases related to inherited IRAs. Also, Roth IRAs might offer greater flexibility when it comes to withdrawing contributions as opposed to earnings. Further, there’s generally no penalty for rolling an IRA over into a 401(k) or annuity plan.

If you’re doing a rollover, you have a 60-day grace period between the time you withdraw funds from one account and the time you deposit them in your new account. People have been known to make use of the available money over the course of those two months. Again, we offer our standard advice to talk this over with a financial advisor.

Oh, and if the IRS garnishes your account to pay back taxes, it does you the favor of not charging you 10% for the privilege.

Borrowing trouble

There’s one last important point to make: You can’t borrow against an IRA.

When it comes to other retirement plans, it’s really pretty easy to dip into them as long as you pay them back.

“Profit-sharing, money purchase, 401(k), 403(b) and 457(b) plans may offer loans,” according to the IRS. “IRAs and IRA-based plans (SEP, SIMPLE IRA and SARSEP plans) cannot offer participant loans. A loan from an IRA or IRA-based plan would result in a prohibited transaction.”

Those employer-sponsored plans can be dipped into as long as you pay it all back within five years and make payments at least quarterly.

Even if it’s an employer-sponsored plan, though, there could be rules in place with which you should familiarize yourself. There’s no legal mandate to offer loans via a 401(k), so not all plans have them. Those that do could have restrictions on minimum amounts, maximum amounts (the IRS forbids borrowing more than 50% of the amount vested), spousal consent or any number of other factors. And there will probably be interest to pay, although it ought to be less than the 10% penalty and loans don’t count as income.

With all that said, it’s best to remember that there’s a reason you opened these accounts. It wasn’t to pay for health care, or you’d have opened a healthcare savings account. It wasn’t to pay for college, or you’d have opened a 529 instead. And it wasn’t to make a consumer purchase. It was to live on after you’ve stopped working. It’s nice to know you can tap this money if you need it, but if at all possible, just keep your retirement money in your retirement account.