| NEW YORK
NEW YORK It's a move of desperation: Raiding your retirement plan to get at the cash because life has thrown you a curve ball.
But desperate economic times may call for desperate measures; sometimes you just have to get cash from somewhere. And if that's the case, there are some ways to get at that retirement money before age 59 ½, without paying the hefty 10 percent penalty which generally applies for touching those funds early.
Of course, it's better not to withdraw money from your 401(k)s or individual retirement accounts before you've retired -- since it is an uphill battle to rebuild savings and few are able to do it.
If you've got emergency savings or taxable accounts, use those funds first. And if you have the ability to take a loan from your 401(k) -- which is generally limited to the one at the company where you now work -- that's a smarter move than an outright withdrawal. However, if you had other options, perhaps you wouldn't be reading this far.
Generally, if you need to take cash out of your retirement plan, whether 401(k) or IRA, before the age of 59 ½, you'll owe income taxes and a 10 percent penalty for early withdrawal. No matter what, you'll still owe the taxes, but there are situations where you can avoid paying the penalty.
You can generally withdraw penalty-free from a 401(k) or IRA if you become permanently disabled, if you need to pay for medical expenses (if they're above 7.5 percent of your adjusted gross income), or if you're facing an Internal Revenue Service levy (that's a tough enough one without the extra penalty).
You can also start a regular retirement stream early, or access income from your retirement funds in regular payments for at least five years till you turn 59½.
The rules on IRAs also allow you to take some cash out penalty-free to pay health insurance premiums if you're unemployed, to help you make a first home purchase, or to cover the costs of college tuition and expenses.
The exception that flies under the radar -- and that may be most useful, especially for those in their 50s who are now struggling (or are hoping to retire early) -- is the one where you start an income stream early.
In Internal Revenue Service parlance, you won't face a penalty for withdrawals if you set up "substantially equal periodic payments" or what's sometimes called 72(t) after the section of the tax code.
"There are certain exceptions to the penalty for people who have logical, normal commitments," explains Allison Shipley, a partner in the personal financial services practice of PricewaterhouseCoopers in Miami. "The one I used to focus on with people is making substantially equal periodic payments. If you need to dip into your savings, but you're still trying to manage it for retirement, you could start a distribution program and save on the penalty."
Taking advantage of this "substantially equal periodic payments" strategy involves a little bit of complicated math, as these annuitized payments have to be calculated based on your life expectancy (or one of two alternate, more complex, methods), and you have follow the IRS's rules closely. But your 401(k) administrator or IRA administrator should be able to walk you through it. There also are online calculators, such as one from Bankrate.com, which can help.
Here's how it works: Say you're 50 years old and have $400,000 in an IRA, and you need some cash but hope to avoid the penalty. You'd look up your life expectancy, then divide your account balance by it, repeating this calculation each year with new figures for both your account balance and life expectancy. In this example, cribbed from the IRS's explainer on the topic, that would be $11,696 in the first year. Once you start taking these payments, you have to continue doing so for at least five years or until you turn 59 ½, whichever is longer.
It doesn't give you a huge amount of cash without penalty, but it might just give you enough. After all, the average amount of a hardship withdrawal from a 401(k) was just $5,510, according to a 2011 study by consultants Aon Hewitt.
"I wish I had known about that," says Vicki Contavespi, a public relations executive, who is still rebuilding her retirement savings with new contributions, after raiding it, in dribs and drabs, during a 13-month period of unemployment a decade ago. "I was only taking money out when I desperately needed to take it."
Since the financial crisis began in 2008, not surprisingly, the number of people raiding their retirement funds has increased: At the end of 2010, 28 percent of active 401(k) participants had loans outstanding, up from 22 percent five years earlier, and another 7 percent took withdrawals, up from 5 percent, according to the Aon Hewitt study.
If you have multiple retirement plans from multiple jobs over the course of your career, you'll need to read the fine print carefully in order to choose which one to tap first.
Not only are the rules for IRAs different from those for 401(k)s, but corporations also may add additional rules on distributions from their own 401(k)s.
"It can be very confusing, and in some cases we're talking about pretty big dollars," says Gil Charney, principal tax research analyst at H&R Block's Tax Institute. "Sometimes it's better to take a distribution from an IRA where a penalty exemption exists than thinking broadly that the penalty exception will exist for the 401(k) when it doesn't."
A final note: If you have a Roth IRA as well as a traditional one, it may make sense to tap the Roth first. That's because you already paid income tax on the money you put in, so if you've held it for five years, and meet the rules for avoiding the penalty, you likely won't have to pay any more tax now.
Hopefully, you'll never have to tap your retirement savings early. But if you do, better to do it wisely.
(Editing by Linda Stern and Andrea Evans)