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February 8, 2021

Early Withdrawal Strategies

Financial Planning Committee

Retirement accounts can be powerful vehicles in helping you grow your nest egg as you plan for your future. Endowed with tax breaks and tax deferral, it is often an easy decision to contribute. That being said, retirement accounts are not so accommodating if you need access to your money sooner than planned. If you make a withdrawal prior to the age of 59 ½, your withdrawal will not only be considered taxable income, but will also incur an additional 10% tax penalty unless an exception applies. The following are just a few ways in which you can gain access to your retirement funds and avoid paying the 10% tax penalty.

All Qualified Retirement Accounts

 Unreimbursed Medical Expenses

If you are under the age of 59 ½, you avoid the 10% tax penalty on withdrawals for unreimbursed medical expenses so long as the withdrawals occur within the same year and do not exceed:

  • The amount you paid for the unreimbursed medical expenses; minus,
  • 10% of your adjusted gross income for the year of the withdrawal.

Qualified Expenses Related to a Birth or Adoption

Starting in 2020, up to $5,000 can be withdrawn penalty-free from an IRA or 401(k) plan to cover expenses for the birth or adoption of a child. The withdrawal must occur within one year after the date of birth or the date on which the adoption of an individual under age 18 is finalized. The adoption of a child who is physically or mentally incapable of self-support is also eligible regardless of age. In addition, the waiver of the 10% tax penalty is on an individual basis so both parents can make withdrawals up to $5,000 for each child born or adopted.

Traditional or Roth IRAs

 Qualified Higher Education Expenses

Funds withdrawn from an IRA prior to the age of 59 ½ that are used for qualified higher education expenses may be exempt from the 10% tax penalty. The education must be furnished at an eligible education institution for you, your spouse, or the children or grandchildren of you or your spouse. In addition, the portion of the withdrawal not subject to the tax penalty is generally equal to or less than the amount of the qualified higher education expense in the year the education is attained.

First-Time Home Purchase

Up to $10,000 withdrawn from an IRA can be used tax penalty-free for the purchase of a first home should you be under the age of 59 ½. The home can be for you, your spouse, the children or grandchildren of you or your spouse, or the parents of you or your spouse. If both you and your spouse are first-time homebuyers, each of you can make withdrawals up to $10,000 for a first home without having to pay the 10% tax penalty. Generally, a first-time homebuyer is defined as not having owned a home in the previous two years.

Qualified Employer-Sponsored Retirement Plans

401(k) Loan

Your 401(k) may allow you to make a withdrawal in the form of a loan. The maximum amount you can borrow is generally $50,000 or 50% of your vested account balance, whichever is less. Repayment of the loan must occur within five years unless used to purchase a primary residence. While a successfully repaid loan may avoid tax and penalty, you will still need to pay yourself interest. If you fail to repay the loan or leave employment while you have an outstanding 401(k) loan balance, the remaining balance is considered taxable income and may be subject to the 10% tax penalty if you are under the age of 59 ½.

As always, please talk with your JNBA Advisory Team if you have questions or would like to explore a conversation with your tax professional about these withdrawal strategies.

Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.

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