Economists have warned that it could take much longer for U.S. employment to recover than the economy as a whole, which is actually not unusual. Employment has taken two or more years to return to peak levels following six of the past 11 recessions.1)
When workers are laid off or transitioning to new ventures, they face a choice about what to do with the assets they have accumulated in employer-sponsored retirement plans. Unfortunately, more than one-third of workers aged 50 to 59 opt to cash out. 2)
There are few ways to sabotage your retirement goals more effectively than tapping your retirement assets before you reach age 59½. Here's why.
Taxes and penalties. Contributions and investment earnings withdrawn from a traditional IRA or an employer-sponsored retirement plan are subject to ordinary income taxes, regardless of the account owner's age (except when withdrawing nondeductible contributions or from a Roth IRA). Investors younger than 59½ can expect to pay a federal income tax penalty equal to 10 percent of the withdrawal, in addition to income taxes.
Opportunity cost. Consider a 50-year-old who has been contributing $1,000 per month to an employer plan that earns a hypothetical 6 percent average annual return (see chart). After he is laid off, he withdraws $25,000 to help supplement his unemployment benefits during his job search. If he is able to return to work and resume annual contributions the following year, his retirement balance at age 65 would be about $88,000 lower than if he hadn't tapped the account and postponed contributions. His retirement savings would be reduced by more than $3.50 for every $1 he withdrew, not including the taxes and penalties he paid on the $25,000 withdrawal.
Strict Exceptions
Even though early withdrawals can have a disastrous effect, they may be unavoidable for some people. In these situations, there are several ways to withdraw money without incurring a penalty. But as you'll see, the rules are strict and complicated. It would be wise to seek help from a tax professional.
* Workers who separate from their employers during or after the calendar year in which they turn age 55 can withdraw from an employer-sponsored retirement plan without a tax penalty.
* IRA owners and individuals with money in a former employer's plan can avoid the 10% penalty by taking a series of equal payments based on life expectancy. The payments must last for five years or until age 59½, whichever is later. Altering the payment amount in any way would trigger a 10% penalty (plus interest) on all distributions before age 59½.
* IRA withdrawals may be penalty-free in cases of the owner's death, disability, or a first-time home purchase ($10,000 lifetime maximum). There is also an exception for qualified higher-education expenses incurred by the IRA owner and his/her spouse, children, and grandchildren.
It's not a good idea to take money from your retirement accounts before you reach age 59½. But if you must, it's a good idea to have a well-designed distribution strategy in place.
1) National Bureau of Economic Research, 2009
2) Hewitt Associates, 2009
This article is provided by Muzette L. Charles. Please be advised that it is not intended as legal or tax advice. Muzette offers securities, annuities and insurance products through AXA Advisors, LLC (member FINRA, SIPC) and its' affiliate, AXA Network, LLC and its subsidiaries. Contact her for a no-obligation review on Retirement, Investment, Life & Long-Term Care Insurance Planning for Individual or Employer Group Plans & Seminar Speaker at 201-592-2501 or www.muzettecharles.com
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