How to Raid Your IRA and 401(k) Retirement Plans
Learn the options for withdrawing funds from your retirement accounts early so you don’t make a costly mistake.
Laura Adams, MBA
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How to Raid Your IRA and 401(k) Retirement Plans
Leslie asks:
I have some high interest loans that I really want to pay off. My credit score isn’t good, so refinancing them for a lower rate isn’t possible. Can I withdraw money or take a loan from my 401(k) or Roth IRA to pay off my expensive debt?
If you’re like Leslie and are itching to raid your retirement account, you need to understand the rules. Different types of retirement accounts have different regulations for withdrawals that occur before you’re officially retired. I’ll tell you what you need to know so you don’t make a major mistake and sacrifice your future.
How Retirement Accounts Work
The rules for retirement accounts were designed to discourage you from dipping into them before retirement—or at least before you reach the official retirement age of 59½. The government gives you money-saving tax breaks to make retirement contributions, but they also charge you tax and penalties when you break the rules. That’s why you should never put money in a retirement account that you might need early.
Additionally, retirement accounts aren’t piggy banks that you can just crack open anytime you want some extra cash. You generally have to complete paperwork to document how you plan to use a withdrawal and, in some cases, provide financial records to prove that you don’t have enough money or assets to cover the expense on your own. Some retirement accounts have strict regulations that make it very difficult to get money out, even if you have a devastating financial hardship.
The Rules for Raiding a Workplace Retirement Account
If you take an early withdrawal from a traditional 401(k) or 403(b), the amount is subject to ordinary income tax plus an additional 10% penalty. There are only a few reasons the IRS even allows you to take a distribution from a workplace retirement plan, and I’ll cover those in just a moment.
Additionally, the retirement plan document that your employer created can further restrict what distributions are allowed. So always refer to your plan document or speak to your benefits administrator at work to fully understand your options.
If it’s permitted by your retirement plan, the IRS generally allows you to withdraw money from a 401(k) or 403(b) in the following 6 circumstances:
- To pay funeral expenses
- To pay health insurance premiums if you become unemployed
- To pay medical expenses
- To pay higher education expenses
- To buy or repair a principal residence
- To make mortgage payments that would prevent foreclosure of your principal residence
Although withdrawals for these 6 situations are allowed, they still incur a 10% penalty. There are several exceptions to the 10% penalty, including death, becoming disabled, or receiving a call to active military duty.
So to answer Leslie’s question: she cannot withdraw money from her 401(k) to pay off debt, because that isn’t a permitted withdrawal reason. However, if her retirement plan allows for loans, that could be an option. Read Should You Take a 401(k) Loan? to find out more.
The Rules for Withdrawing From a Traditional IRA
Unlike your workplace 401(k), IRAs give you a little more flexibility because you control them, not an employer. However, loans are not permitted from any type of IRA-based retirement plan. You can withdraw money from them, but it’s subject to the same consequences, income tax plus a 10% penalty, if you’re younger than age 59½.
IRAs have the same exceptions to the 10% penalty as workplace plans, but they also waive the additional 10% tax for health insurance if you’re unemployed, higher education expenses, and up to $10,000 to buy your first home.
The Rules for Withdrawing From a Roth IRA
If you’re like Leslie, you might be wondering if you should raid your Roth IRA. A Roth IRA gives you the most flexibility for taking withdrawals because the money you put in has already been taxed, unlike a traditional IRA or 401(k) where you make pre-tax contributions.
That means withdrawing contributions from a Roth IRA doesn’t trigger income tax or a penalty. However, the earnings in your Roth are handled differently because they haven’t been taxed. Withdrawing earnings results in having to pay income tax plus the 10% penalty.
[[AdMiddle]For example, let’s say you made a one-time contribution of $5,000 to your Roth IRA. The account has grown in value and is now worth $6,000. You can withdraw $5,000 with no tax consequences, but tapping the earnings portion of $1,000 ($6,000 current value – $5,000 contribution) would generally trigger income tax plus the 10% penalty. That means Leslie could tap her Roth IRA to pay off her high interest debt.
6 Reasons Why You Shouldn’t Raid a Retirement Account
Now that you understand the options for raiding common types of retirement accounts, the real question is, should you? Here are 6 reasons why raiding your retirement nest egg is a bad idea:
- Paying a 10% penalty takes a huge bite out of your account value
- Withdrawals that increase your taxable income can launch you into a higher tax bracket, costing you even more
- Withdrawals can’t just be paid back—you’re subject to annual contribution limits
- Workplace plans generally forbid you to make new contributions for 6 months following a hardship withdrawal
- You lose out on years, or even decades, of future account growth
- Retirement accounts enjoy certain protections against creditors and in lawsuits
If Leslie wants to pay down her high interest debt, the best plan is to suspend making payments to her retirement accounts, instead of raiding them. By sending additional payments to debts, you can pay them off much faster without sacrificing your future financial security.
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More Resources:
Publication 590opens PDF file , Individual Retirement Arrangements (IRAs)
Publication 575opens PDF file , Pension and Annuity Income
Chart showing exceptions to the 10% additional taxopens PDF file
Top 10 Facts about Taking Early Distributions from Retirement Plans
Tax on Early Distributions from Retirement Plans
Can You Avoid Early Withdrawal Penalties on Retirement Accounts?
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About the Author
Laura Adams received an MBA from the University of Florida. She’s an award-winning personal finance author, speaker, and consumer advocate who is a frequent, trusted source for the national media. Money-Smart Solopreneur: A Personal Finance System for Freelancers, Entrepreneurs, and Side-Hustlers is her newest title. Laura’s previous book, Debt-Free Blueprint: How to Get Out of Debt and Build a Financial Life You Love, was an Amazon #1 New Release. Do you have a money question? Call the Money Girl listener line at 302-364-0308. Your question could be featured on the show.