Armchair Millionaire Community Bulletin: The Perils of Cashing IRAs Out Early

Many people have plenty stashed away for retirement in IRAs and 401(k)s, but believe they have no way to tap those funds early without paying a penalty. Here are the options for getting at that money, without the penalty.

(PRWEB) April 28, 2004 -- In most cases when you take money out of a retirement account (such as a 401(k) or IRA) before you reach the age of 59 1/2, you're faced with a 10 percent penalty. That should be enough to deter most people, including you.

In fact, when we asked members of the Armchair Millionaire community about tapping their retirement funds early, we nearly universally heard regret from those who had done so. Here is just one of those comments:

"I've cashed out my 401(k) twice. Once when I changed jobs and once when I changed jobs and at the same time was going through a divorce. In both situations I regret it and just wish I knew then what I know now. Unless I'm about to be literally kicked out of my house because of no cash flow, there is no other situation I can imagine where I would cash out my 401(k). I would go into deep credit card debt before I cash out my 401(k) again. --Mattchiavo

The good news for you is that there are some exceptions to the early withdrawal rules that let you start your retirement withdrawals early without incurring the 10 percent penalty. However, proceed very carefully here: The rules are complicated so you should seek professional tax advice before plunging ahead.

(In addition, there are a host of other emergency situations-unrelated to retirement--which will allow you to withdraw retirement money early, penalty-free, but the rules and conditions are too extensive to cover in brief.)

One point that I cant make strongly enough:, you should be absolutely sure that using your retirement money now won't mean that you run out of money later.

If you decide to go ahead, my guide will provide you with the basics on your options.

The Armchair Millionaire's Guide to Cashing Out Early
Tap your traditional IRA. You'll avoid the early withdrawal penalty if you take payments from your traditional IRA in what the IRS calls a series of "substantially equal periodic payments" over your lifetime expectancy. You are required to take at least one payment per year, and the amount is determined by the IRS's life expectancy tables. Remember though, that even though you will avoid the penalty, you'll still have to pay regular income taxes on the money you withdraw.

Tap your Roth IRA. You can always withdraw you contributions to your Roth IRA without paying tax or a penalty (after all, you already paid the tax on these contributions). Money that was converted from a traditional IRA and your earnings are treated differently, however. Again, you may be able to avoid the 10 percent penalty on these if you take the money as a series of payments over your lifetime, but the rules are especially complicated here, so you will definitely want to seek advice from a tax professional.

Tap your 401(k). If you leave your company at age 55 or older, you're eligible to take your 401(k) money as a lump sum without paying the early withdrawal penalty. Depending on your company's rules, you may be able to a specific amount of money out from the plan on a regular basis if you're younger than 55, again under the "substantially equal periodic payments" rule.

The Bottom Line: Uncle Sam is very serious about you keeping your money stashed away for retirement until you're at least 59 1/2. While there are ways to get at that money early without paying a penalty, you should do so only when you're certain that you won't sabotage your later retirement years.

This column appears each week on CNNMoney.com, the Web sites for CNN and Money Magazine.

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ArmchairMillionaire.com was founded in 1997. The company's first book, The Armchair Millionaire, was published in 2001. Today, www.ArmchairMillionaire.com is an established community of common sense savers and investors.