Don't Withdraw From Your IRA Before Age 59 1/2 -- Here's Why

Key Points

• Withdrawing money from your IRA if you're under 59 1/2 triggers a 10% early-withdrawal penalty.

• There are exceptions to this rule if you meet certain criteria.

• But you'll also set yourself back in meeting your retirement savings goals.

• The $23,760 Social Security bonus most retirees completely overlook ›

When you need cash, whether to fund early retirement or just to help you out in a pinch, your IRA can start to look pretty tempting. It's your money, so there's no need to bother with a bunch of paperwork like you might encounter if you were taking out a loan. All you need to do is withdraw the funds and spend them.

The drawbacks of your early IRA withdrawal may not become obvious until tax time, when you find yourself facing an unusually large bill. But that's not the only reason you may want to find another way to cover your expenses before you turn 59 1/2.

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The tax consequences of early IRA withdrawals

IRAs are tax-advantaged accounts, which means they offer special tax savings either now or in retirement. The government regulates these accounts closely, and places limits on how much you can contribute to them each year and on when you can withdraw the funds. It considers withdrawals made before you turn 59 1/2 to be early withdrawals, which are usually subject to a 10% early-withdrawal penalty. You'll also pay ordinary income tax, if the money comes from a traditional IRA.

There are some exceptions, though. First, if you're taking money from a Roth IRA and you're only withdrawing funds you've contributed rather than investment earnings, you won't face a penalty. You've already paid taxes on those Roth IRA contributions in the year you made them, so the government lets that slide.

You can also take an early IRA withdrawal without facing a 10% penalty for any of the following reasons:

• Birth or adoption expenses (up to $5,000 per child)
• Total and permanent disability
• Economic loss because of a federally declared disaster (up to $22,000)
• Being a victim of domestic abuse (up to the lesser of $10,000 or 50% of your balance)
• Qualified higher education expenses
• Emergency personal expense (once per calendar year, up to the lesser of $1,000 or the amount by which your vested account balance exceeds $1,000)
• Substantially Equal Periodic Payments (SEPPs)
• First home purchase (up to $10,000)
• Medical expenses in excess of 7.5% of your adjusted gross income (AGI)
• Being a qualified military reservist called to active duty
• Health insurance premiums while you're unemployed for 12 weeks and have received unemployment compensation

Note that in each of these cases, you'll still owe ordinary income taxes on your withdrawals if the money comes from a traditional, tax-deferred IRA.

The long-term costs of early IRA withdrawals

Losing an extra 10% of your retirement savings to the IRS is already a pretty big blow, but that's only part of the problem. If, for example, you took $10,000 from your IRA early and without a qualifying reason, you would pay taxes and the 10% early withdrawal penalty on that amount. But you'd also miss out on investment earnings you could have had if you'd left that money alone.

If that $10,000 had remained in your IRA for 20 years and you'd earned a 10% average annual return on it during that time, it would be worth over $67,000. That's what you're really giving up when you take money from your retirement account early.

This isn't to say you should never make an early IRA withdrawal. If you're unable to take out an affordable loan and you need the money quickly, you may have no other option. But it's always worth checking to see whether there are other solutions available to you first.

Depending on what you need the money for, you may be able to take out a mortgage or auto loan. Personal loans enable you to use the money for whatever you want, though their interest rates are a little higher since they're backed by nothing but your word. Steer clear of payday loans and other high-interest debt: They can trap you into a debt cycle that takes months or years to get out of.

If you don't need the money immediately, delaying your purchase could give you extra time to save up the cash on your own. Or, if you owe a large medical bill, for example, you may be able to work out a payment plan with the creditor so you don't have to pay it all back at once.

If you have a 401(k), check to see whether your plan allows you to take out a 401(k) loan instead. This will still result in some lost investment earnings, but since you're supposed to pay yourself back with interest over time, you may not lose quite as much. Plus, if you stick to the loan terms, you can avoid the 10% early withdrawal penalty for withdrawals under age 59 1/2.

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