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4 Times it’s OK to Dip into Your Retirement Fund Early

Morgan Quinn / TNJ | 8/3/2016, midnight
Taking an early withdrawal from your 401(k) is not only costly in the short term, it can also jeopardize your ...

Taking an early withdrawal from your 401(k) is not only costly in the short term, it can also jeopardize your long-term retirement goals. If you withdraw retirement accounts before the penalty-free 401(k) withdrawal age of 59.5, you’ll be forfeiting the benefits of tax-deferred earnings and compounding interest, which diminishes the savings power of 401(k) accounts. These plans are specifically designed for long-term investing, making the years work in the contributor’s favor.

Because of the severe financial penalties, withdrawing money early from retirement accounts should only be done in an extreme emergency, ideally after any emergency funds and investments have been depleted. If you are in a financial pinch and considering taking money out of your 401(k) or any other retirement savings account, here are four times it’s OK to dip into your retirement fund early.

4 SITUATIONS WHEN YOU CAN WITHDRAW MONEY FROM YOUR RETIREMENT SAVINGS

Certain qualifying situations allow for a penalty-free hardship withdrawal, but employers are not required to provide these kinds of 401(k) withdrawal rules. Some people have to take the hit of the penalty for withdrawing early from retirement savings just to stay financially afloat.

Emily LaRusch, founder of Back Office Betties, which offers full-time virtual receptionists, has experienced this firsthand. “In 2010, I was days away from having my second baby when I was laid off,” LaRusch said. “I made the decision to close my 401(k) and accept the penalties in order to support my family while I stayed at home for the first year with my son.”

In extreme situations like LaRusch’s, after carefully thinking it through and running the numbers with a 401(k) withdrawal calculator, you might find it’s still in your best interest to make a 401(k) withdrawal or other type of early distribution — even if there are penalties. If you find yourself in one of the following scenarios, withdrawing money early from your retirement savings might be financially prudent.

YOU BECOME TOTALLY AND PERMANENTLY DISABLED

You can take penalty-free distributions from qualified plans due to a total or permanent disability. Minor or partial disabilities don’t qualify.

According to the IRS, you are considered disabled if:

—You can provide proof that you cannot do any substantial gainful activity because of your physical or mental condition.

—A physician determines that your condition can be expected to result in death or to be of long, continued and indefinite duration.

Some experts recommend first applying for state disability insurance to make it easier to prove your status to the retirement plan administrator. To take a 401(k) hardship withdrawal, you must fill out IRS Form 5329 to get out of paying the penalty and ensure you are adhering to IRS 401(k) loan rules.

YOU’RE DROWNING IN MEDICAL DEBT

You can withdraw from your retirement accounts to cover unreimbursed, out-of-pocket medical expenses that exceed 10 percent of your adjusted gross income. These expenses must be paid in the same year you take the distribution and the distribution is not subject to penalty of tax if withdrawn from an IRA.