Can I take money out of my Individual Retirement Account (IRA) while working?
Yes, you can take distribution from your IRA. The fact you are working does not affect your eligibility, but there may be certain tax/penalties to be paid, as described below.
1. If the account is a Traditional IRA, you have to pay income tax on the amount taken out (as the taxation was deferred to the distribution time, so you never paid taxes on it), and if you are under 59 1/2 also, a 10% penalty, subject to below exceptions.
2. If the account is a Roth IRA, a) the distribution is made after 5 year from the first contribution, AND b) the owner is 59 1/2, entire distribution is tax-free and penalty free.
If, however, one of the above is not met, then the distributions will be segregated by their nature
- contributions (always tax-free and penalty free)
- conversions (tax-free but subject to 10% penalty if less than 5 years)
- earnings (will be taxed and 10% penalty will apply)
Distributions have to be taken in the following order: First contributions, then conversions, and last earnings.
Example; If the account has $7,000 in total: $5,500 from contributions, $1,000 from conversions, and $500 from earnings. If $6,000 is distributed, the first $5,500 will be tax-free and penalty free while $500 (from conversions) gets a 10% penalty, or $50. If, however, the entire $7,000 is needed, the $1,000 will get a penalty of $100, and the earnings will be taxed as ordinary income, and a penalty of $50.
3. Simple-IRA- If a distribution is taken within the first 2 years of establishing the plan, the penalty increases from 10% to 25%. After the 2 years, it becomes 10%, like for the above two IRAs.
Exceptions to the 10% penalty apply to all the IRA accounts above:
- made to the beneficiary of the account's estate at the death of the beneficiary
- if account owner is disabled
- if substantial equal periodic payments are initiated (Section 72(t)) based on your life expectancy, which can not be reversed once initiated
- for medical expenses in excess of 7.5% of your AGI (adjusted gross income)
- for higher education expenses
- for first-time home purchase (up to $10,000)
- payment of health insurance premiums by unemployed
- IRS levy
- a qualified reservist distribution
As a planning strategy, it is best to take money from the contributions to a Roth first, instead of withdrawing from the Traditional or Simple IRA, if you have the option.
Alternative sources, if you have, would be best, like a brokerage account, a loan within a 401(k) (up to 50% of the amount, max $50K usually, or according to the plan document).
Alina Parizianu, MBA, CFP®
Yes, you can take money out of your IRA plan if you’re still working, but you may not want to for three main reasons.
The first is the possible tax penalties. If you take money out of a traditional IRA before age 59.5, you’ll usually pay a 10% federal tax penalty (and possible state tax penalties as well) on the amount withdrawn. Early withdrawals without penalty are allowed in the following situations:
- Up to $10,000 for a “first time” home purchase (meaning you haven’t owned a home in the last two years),
- For qualified education expenses (tuition, fees, room and board, textbooks and other required expenses for yourself, your kids, your spouse or your grandkids at any school that has been approved under the federal student aid program)
- To make ends meet if you become disabled
- To pay for unreimbursed medical expenses exceeding 7.5% of your adjusted gross income
- To pay for health insurance premiums while you’re unemployed for 12 weeks or more
If you have a Roth IRA, you can take out your contributions at any time without penalty since you’ve already paid tax on the contributions. However, you cannot remove earnings without penalty until age 59.5 unless you become disabled or make a qualified first-time home purchase. There is also a five-year aging requirement, meaning that if you want to withdraw earnings tax free and penalty free for one of these two approved early withdrawal purposes, your Roth account must be at least five years old.
The second is taxes. You’ll pay taxes on the amount withdrawn from a traditional IRA regardless of your age because your contributions were pretax. Your tax rate while you’re working might be higher than your tax rate in retirement, so it can cost you more in taxes to take a traditional IRA distribution while you’re still working.
The third is the harm you might cause to your long-term financial plan. Any money you withdraw early is not only money you won’t have later; you’re also sacrificing the years of compound returns you could have earned on that money.
Finally, you can start taking early distributions from your IRA without penalty if you take substantially equal periodic payments, meaning you take the distributions on a regular schedule in amounts based on your life expectancy.
You can always withdraw funds from any of your savings or retirement accounts at any time. But doing so may result in the imposition of federal and state tax, and potentially a 10% early-withdrawal penalty, depending on your circumstances.
First, I'll discuss something that may apply to you, since you're still earning wages. I'll follow this up with detail outlining the rules and penalties, by age, related to Traditional IRA withdrawals.
You mention you're still earning money, but want to know if you can withdraw from your IRA at this time. Below, I detail the standard rules for withdrawal (penalty-free) from traditional IRAs, which vary based on age. BUT IF YOU ARE SELF-EMPLOYED, WORKING FREELANCE, or DOING SIDE-GIGS, you may want to consider a SEP IRA.
This is called a "Simplified Employee Pension Plan", even if you have a full-time job as an employee, if you earn money freelancing or running a small business on the side, you could take advantage of the potential tax benefits of a SEP IRA. The SEP IRA is similar to a traditional IRA, where contributions may be tax-deductible, but the SEP IRA has a much higher contribution limit. The amount you can contribute varies based on your earned income. For SEP IRAs, ou can save 25% of pre-tax income, up to a $53,000 limit for 2016 ($54,000 for 2017 contributions). The deadline to set up this account is the tax deadline, so for purposes of filing your 2016 taxes, this would be April 18, 2017. But, you can also request an extension in filing your return, giving you another 6 months or so to set up a SEP IRA or deposit contributions.
TRADITIONAL IRAs (defined):
An IRA is set up at a financial institution that enables an individual to save for retirement on a tax deferred basis, meaning you are not taxed on earnings generated so long as they're placed into the IRA, but upon withdrawal (typically in retirement, when your income is low and thus your tax rate is far lower), taxes are payable.
WITHDRAWAL RULES - TRADITIONAL IRAs
Taking money out of an IRA is referred to as a "distribution." Since the account is intended to help you save for retirement, the tax-advantages are available for those who keep funds in the account until they have retired. If you withdraw funds early, you'll miss out on the powerful tax benefits associated with the IRA structure and may reduce the amount of money you will have available when you need it. You may also incur PENALTIES.
With Traditional IRAs, you defer taxes until you begin to withdraw money. The rules vary depending on your age, and you can avoid early withdrawal penalties under select circumstances (described below).
WITHDRAWALS PRIOR TO AGE 59.5:
- Distributions taken prior to age 59.5 are subject to a 10% withdrawal penalty, on top of federal and state taxes.
- BUT, under certain circumstances the 10% withdrawal penalty does not apply:
- If the money is withdrawn and used toward a first-time home purchase
- If the withdrawal is used to pay for qualified education spendings
- Death or Disability
- Funds withdrawn to pay for Unreimbursed Medical Expenses
- Funds used to purchase Health Insurance if you're unemploye
- If one of the above exceptions applies to you, you may need to file IRS Form 5329 when filing your tax returns.
- BUT, under certain circumstances the 10% withdrawal penalty does not apply:
WITHDRAWALS BETWEEN 59.5 and 70.5:
- Starting at age 59.5, you may begin taking money out of your retirement accounts without penalty. Bear in mind that you'll have to pay any Federal or State taxes that might be due, but you will not incur any penalties at this stage.
Yes. Income taxes will always be applicable unless it is a Roth. And, if you are younger than 59 1/2 years of age, then an additional 10% penalty is added to the tax in most cases. For specifics on your personal situation, consult your tax preparation professional who can answer all your questions.
Yes, but it will be taxed as ordinary income and if you are under age 59 1/2, there will be a 10% penalty. However, the 10% penalty can be avoided if you qualify for certain exceptions like disability, health insurance premiums, first home purchase up to $10,000, qualified higher education for you, your spouse, children or grandchildren, qualified reservists distributions, or "72(t) Payments" (IRS Code). These 72(t) periodic payments must be taken over a minimum of 5 years or until age 59 1/2, whichever is later. There are 3 approved methods to calculate and must be done correctly. And once started, cannot be turned off.
Hope this helps and best of luck, Dan Stewart CFA®