Retirement account gaffes: Clients’ biggest withdrawal mistakes
From: www.financial-planning.com
Baby boomers in the job market grapple with a persistent worry: What if I have a financial emergency that compels an early withdrawal from my retirement account? The income tax hit alone is painful but, unless an exception applies, the additional 10% penalty for those (usually) under age 59 1/2 applies salt in the wound.
The good news is that tax law provides exceptions to such penalties — for example, for employees over age 55 and age 50 who withdraw from company plans after separating from service. But it’s important to know that not every exception applies to every type of retirement plan.
Some apply only to distributions from IRAs, while others apply only to distributions from company plans. Other exceptions apply to both. The exception for higher education, for example, only applies to distributions from IRAs, not company plans. If the client has funds in a 401(k) and those funds are eligible for rollover, the advisor should first roll them over to an IRA and then withdraw from the IRA to qualify for the exception.
Even if the funds are correctly used for education, if they are withdrawn from the 401(k), the 10% penalty exception will not apply. In numerous U.S. Tax Court cases, taxpayers had to pay the 10% early withdrawal penalty because the exception they claimed did not apply to the plan that they took the distribution from. We see the biggest errors here with first-time homebuyers and in higher education in which exceptions apply only to distributions from IRAs and never from company plans.
