Making distributions before the age of 59 1/2 from IRA's, SEP's, Keogh Plans, 401(k)s, and annuities requires the payment of a 10% tax penalty, except in certain limited situations.
The government assesses the penalty to prevent taxpayers from using these plans as a short-term way of reducing taxes, and to encourage you to wait until retirement to withdraw funds. In the event of death or disability, these funds can be withdrawn without penalty. But many taxpayers have other legitimate needs that could be satisfied by accessing these funds.
When to Withdraw
You wouldn't want to use these funds for a vacation or to buy an new car. But perhaps you retired early and need additional income until you can collect Social Security benefits. You may have been laid off from your former job and your new job pays significantly less. You may face large, temporary college bills for your children or large unexpected bills for a parent's nursing home costs. Access to your retirement funds would ease the burden but the 10% penalty tax is a stiff price to pay.
By setting up a payment schedule that results in substantially equal amounts over your life expectancy, you can utilize the funds without paying the penalty. No minimum age requirement exists to do this and you do not have to explain why you are making the withdrawals.
Although the amounts are based on your life expectancy, you do not have to receive them for that length of time. Once you start making withdrawals, you must continue at that same level for five years or until age 59 1/2, whichever is later. If you stop making withdrawals or change the amount before the time limit, the 10% penalty will be retroactively levied on all distributions before age 59 1/2. After that, you can continue the payments, change the amount or stop the payments completely.
How Much to Withdraw
There are three methods to calculate the amount of your withdrawal — life expectancy, amortization, and annuitization. The life expectancy method generally results in the lowest withdrawal amount and involves dividing your balance by line expectancy, as determined by the IRS tables. The amortization and annuitization methods allow you to factor in larger withdrawals.
If the amounts calculated are more than the amount you want to withdraw, you can split your plans into separate accounts and only make withdrawals from one of the accounts.
For more retirement planning and investment advice, e-mail a Provident Financial Consultant* or call (650) 508-7222 or (800) 656-4096. Provident offers a full range of Investment and Retirement Planning services.