13 Oct I Lost My Job. Can I Tap into Retirement Funds without Penalty?
If you’ve lost your job or quit, and you need to tap into retirement funds in order to help cover day-to-day expenses, there are rules you need to be aware of before you make the move.
Throughout my 24+ years as a financial advisor, I can’t count how many times I’ve been asked about this. It is more common than you might think.
While tapping into retirement savings is the last thing you want to do, sometimes it’s necessary to feed our families and stay afloat.
I get it.
But if you are going to tap into retirement funds, you need to understand that the consequences (taxes and penalties) depend on the type of retirement account(s) you have.
Because not all retirement accounts are created equal.
There are different options between an IRA and a 401(k) for example – and different penalties for withdrawing from each.
If you don’t understand the tax and penalties BEFORE you withdraw, you’re going to end up with a lot LESS money than you expected.
Keep reading for a breakdown of the pros and cons of withdrawing money from various retirement accounts.
Warning: A quick google search pulls up many financial blogs that are giving bad advice, the writers don’t know the tax code, and then many of them put disclosures at the bottom of their site that says the content isn’t financial advice. Be careful where you source your information.
Withdrawing from a 401(k) or Other Workplace Retirement Account
If you have a workplace retirement account – such as a 401(k), 403(b), or 457 plan – and you absolutely need to tap into your funds to live, you need to understand the rules before you make your move.
If you’re signing up for unemployment due to a job loss: Check with your state unemployment division to see if they consider a withdrawal from your workplace retirement as income, which could disqualify or limit you from receiving unemployment benefits. Expect a dollar-for-dollar reduction of your unemployment benefits if withdrawing from your 401(k) or other workplace retirement account.
If you are under age 59½: It doesn’t matter if you were laid off or quit, you will owe a 10% penalty on all funds withdrawn, as well as taxes. The amount withdrawn will be taxed as ordinary income.
If you are age 55 and over AND left your place of employment: You will not pay the 10% penalty on funds withdrawn. However, you will still owe taxes on the withdrawal, and funds withdrawn will be taxed as ordinary income.
This is what is called the 55 and Separated from Service rule. This is an IRS policy that allows workers aged 55 and over to take early withdrawals from their employer-sponsored retirement accounts without paying a 10% penalty provided that they leave their jobs. It only applies to accounts you have with your current employer.
401(k) Rollover Warning for Those 55 and Over, but Under 59½
If you lost your job or quit and decided to roll over your old 401(k) to an IRA and you are over 55, but under age 59½…once the funds reach the IRA, you now cannot withdraw any funds penalty-free until age 59½.
However, if you had left your funds in your old 401(k) with your previous employer, you could take out penalty-free withdrawals as you need them. You still would be responsible for taxes, but pay no penalties.
Withdrawing from a Traditional IRA
If you have a traditional IRA account and need to tap into your funds just to live, here’s what you need to know.
If you are under age 59½: It doesn’t matter if you were laid off or quit, you will owe a 10% penalty on all funds withdrawn, as well as taxes. The amount withdrawn will be taxed as ordinary income.
If you’re signing up for unemployment due to a job loss: Check with your state unemployment division to see if they consider a withdrawal from your workplace retirement as income, which could disqualify or limit you from receiving unemployment benefits. Expect a dollar-for-dollar reduction of your unemployment benefits if withdrawing from your traditional IRA.
Withdrawing from a Roth IRA
If you have a Roth IRA account and need to tap into your funds to live, you may want to tap these funds first.
Here’s why:
- You will pay NO penalty on withdrawals of your contributions at any time.
- You will pay NO taxes on withdrawals of your contributions at any time.
- Contributions withdrawn do not count as income toward unemployment benefits.
As you can see, Roth IRAs have better terms for early withdrawals than a traditional IRA.
If you need funds for a qualified emergency, you will not be penalized for early withdrawals of your contributions.
The 10% penalty will only be on the earnings if they are withdrawn prior to age 59½.
There are a few exceptions to this rule such as:
- First-time home purchase
- College expenses
- Birth or adoption expenses
- To pay for health insurance if you are self-employed
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