In this episode of Adam Talks, IRA Financial’s Adam Bergman Esq. discusses ways to tap your retirement account without getting hit with the early distribution penalty.

Taking Money out of your IRA or 401(k) Without Penalty

Hey everyone, Adam Bergman here, tax attorney and founder of IRA Financial. Welcome to an another episode of Adam Talks. Today, we’re going to chat about best ways to pull money out of your IRA or 401(k) without paying that 10% early distribution penalty. So, I may not have all the answers that you can pull out your money tax-free out of a pretax IRA or 401(k), because even I don’t have all those answers because sometimes it’s just not possible, other than a Roth IRA contribution or Roth IRA distributions when you’re over 59 and a half and the Roth has been open at least five years. Really no good ways to pull money out of a retirement plan without tax, but I can tell you ways to get out your money without the 10% early distribution penalty, which applies when you pull money out of an IRA or 401(k) before the age of 59 and a half.

So, before I get started with the IRA and 401(k) rules, what’s going on, right? We don’t have to spend much time talking about the economy. We’re all living through it. We have significant inflation, 8-9%. The labor market is still tight, which is great. People have jobs. There’s demand for jobs. So that’s keeping the economy flowed. But, with prices increasing greater than people price increase at work; rents, mortgage interest rates going up, cost of food, cost of entertainment, cost of travel, cost of everything, gas, of course, up. I’ve, probably since 2010, the last two months is the second most questions and demand that we’ve received from people looking to get access to their IRA or 401(k).

So, I wanted to do a podcast to talk away. Hey, things happen, right? We all need to deal with stuff. Retirement accounts, yes, they are for retirement, for our future, they’re for our families, hopefully, we don’t even need to touch it, and it’s for kids. But crap happens in life and sometimes you need to tap into to pay for health, pay for shortfall and savings to pay for certain unexpected costs that pop up. And this is the main purpose of today’s podcast, is to explain, okay, now we know you need to tap into your IRA or 401(k) because for most people, that’s their largest source of savings, and that’s where the money is liquid, right? It’s not easy to just tap into home equity in your house or sell your car, right? Or sell your diamond ring or your watch, right? Just sometimes not practical and just not very economical. So, people look to their IRA or 401(k) because that’s usually the biggest chunk of savings. There’s $13 trillion in retirement accounts, give or take. $13 trillion of IRAs, $33 trillion of overall retirement accounts, including 401(k)s and pension plans; so, lots of money.

Let’s start in the 401(k) world. Believe it or not, and I’ve said this on many videos, not everyone has access to their 401(k). So, if you basically are under the age of 59 and a half and are currently employed with the employer that houses your 401(k), you’re not going to be able to touch your 401(k) funds. Generally exceptions, so you leave your job; but let’s say you don’t want to leave your job. What are the ways you can get money out of your 401(k)? Two ways.

If your 401(k) has a loan option, you can borrow $50,000 or 50% of your account value, whatever’s less, and use that for any purpose. That’s number one. Number two, hardship distribution. If you can show that you have a hardship, then you’re able to pull money out of your 401(k); have the ability to pull it out, that’s number one, right? Because remember, without a hardship, without getting access to a loan, if you’re under 59 and a half and you’re currently employed, you’re not going to get access to your retirement plan, even if you want it. Other way to do it is quit. But if you don’t want to quit and you’re under 59 and a half, you’re not going to get access to your money. So, if you’re sitting there saying, hey, I have $200 grand in my 401(k), I need to use $30-40K of it, you have two options: you can do the loan; if that doesn’t work, either because the plan doesn’t have a loan option, then the other is proving a hardship.

And what’s a hardship? Hardship is basically, you need to show immediate and heavy financial need. And it’s generally up to the employer to determine if the participant is in immediate and heavy financial need. Now there’s safe harbor regulations came out that make it easier for employees to show that they have a hardship and essentially you need to show that there is a real immediate and heavy financial need and you’re only taking out what you need, right? If you say you’re heavy financial need is $30 grand but you want $100K, that’s generally not going to fly, okay? It basically comes down to relevant facts and circumstances. So, if you need to buy a boat or TV, that’s generally not considered immediate and heavy. It has to be immediate and heavy, even if it’s reasonably foreseeable that this could have arisen.

So, a distribution is automatically considered to be necessary to satisfy an immediate heavy financial need if all the following requirements are met. Number one, the distribution isn’t greater than the amount of the immediate and heavy financial need. The employee has obtained all the currently available distributions, okay? So, this is your last resort, including loans. And third, the employee isn’t allowed to make elective deferrals for at least six months. Why? Because, hey, if you need the money so badly but you’re still doing elective deferrals, maybe it’s not such a heavy need, okay? So, the rules aren’t that difficult to satisfy. Yes, it’s up to the employer to basically agree to it. In my experience, just working with thousands of plans, it’s very rare that an employer is going to deny your request for having financial need.

Now generally, most people just go to the loan option first, which you can borrow 50,000 or 50% of your account, whatever is less. But, if that’s not available, then you generally can’t pull some of the money out without 10% penalty. Now remember, you still have to pay tax on what you pull out, and the money is not going to be able to be put back in the plan, unlike a loan where you’re paying back your plan, but you get to escape the 10% early distribution penalty. And that’s really the core of this podcast, right? I can’t tell you ways how to pull money out tax free but I can tell you ways to escape the 10% early distribution penalty.

Now, under the safe harbor IRS regulations, an employee is automatically considered to meet the immediate heavy financial need if medical care expenses for the employee or the spouse or dependent of the employee. So, if you could show it’s for medical care expense you can meet it; cost directly related to the purchase of employee’s principal residence, excluding mortgage; tuition related educational fees, room and board expenses for the twelve next months; payments necessary for an eviction; funeral expenses; and certain expenses to repair damage to a principal residence. Again, it’s still limited to the amount necessary and you have to show you basically can’t obtain the funds from other sources.

So, the safe harbor rules,, that which were propagated in 2017, make it easier now to satisfy the distribution hardship rules in a 401(k); makes it easier on the employer as well because as long as you can show you meet one of these safe harbors, which are super broad, you can get the money without the 10% penalty. So, remember, if you need money and you have money in a 401(k), the first thing you should be looking at is the loan. Why? Because yes, you have to pay that money back but at least you’re paying it back to your plan and the money, let’s say it’s 5 1/2% interest or 6% interest, depending where rates are, at least that 6% interest is going to your plan account. Whereas, if you take a hardship that money is gone. You don’t have to pay it back. You do have to pay tax on it though. A loan, there’s no tax on what you pull out and that money gets to go back into the plan and the plan is getting a return on the loan by the interest rate. With a hardship, you escape the 10% penalty, tax is due but those funds are gone. They can never be returned to the plan, which is definitely a major negative.

So, that’s the 401(k) world, let’s move into the IRA world and again you’ll see in the IRA world, it’s actually easier to get a hardship from a 401(k). Strange, right? Because the IRA rules are super flexible. Unlike a 401(k), you do not need a triggering event to pull money out of an IRA, pretax IRA. Anyone can pull money out at any time. The station is if you have a pretax IRA and you’re under the age of 59 and a half, you have to pay tax and a 10% penalty. Tax is based off the amount you pull out; it’s an ordinary income tax, not a capital gains tax. And whatever you pull out’s added to your other income, and that will determine your tax rate. The 10% applies to the amount you pull out. So, if you pull out $50,000, you’re going to pay tax plus $5,000 on that $50,000. Okay, so that’s the 10%. The hardship gets you around the 10%; still have to pay tax on what you pull up, but you escape the 10%.

Now, unlike a 401(k), there’s no financial hardship exception. Why? Because you can pull out money anytime you want, right? So, if you’re in financial hardship, pull it out and pay the 10%. But there are other exceptions in the IRA world. So, if you are disabled, if you’re permanently disabled, you can pull the money out without a 10% penalty. You can do something called a substantial equal periodic payment, where you can pull out a certain amount of money over the period of time without a 10% penalty. You can pull up to $10,000 to buy a home, okay? Qualified, first-time home purchase. Yeah, I wish that $10,000 was more, but, especially with the way home prices are and the way they’ve risen the last two, three years, ten grand is helpful, but not enough. Qualified higher education expenses. If you can show the money is going to be used for that, you can pull it out without the 10% penalty. Health insurance premiums. Okay, that also is an option. Obviously, the government; if you have an IRS levy, you can pull the money out without the 10% penalty. And essentially, if it’s a qualified disaster, you could also do that or up to $5,000 for an adoption.

All these are hardships that you could use, but you still have to pay tax. You just escape the 10% penalty. Unlike a 401(k), IRAs do not have immediate heavy financial need. Why? Because they say, you have the ability to pull it out, you do have to pay 10%, which is unfair because a 401(k) does not have that 10% requirement, but 401(k)s have triggering event rules, where if you don’t satisfy a hardship, you can’t pull the money out. That’s why there’s immediate and heavy financial need for 401(k)s, because they need a trigger event where the IRAs do not need to trigger an event because you can pull it out anytime, you just have to pay the 10%.

These also apply to Roths. Roth contributions can be, once you make them, you can pull them out. But, if you want to pull the earnings on the contribution, you have to wait your 59 and a half and the Roth’s been open at least five years. I would strongly suggest hesitating and thinking through if you want to do hardships on Roths, because Roths are like gold, right? If you can be patient and wait out the 59 and five year, it’s all tax free. On the flip side, I do understand life happens; we all deal with emergencies and difficult situations, so do what you got to do. Number one priority is your immediate family needs today, not in 30 years, so I got you, right? I know and I lived what happened in 2008, 2009, 2010. Hopefully ’22, ’23 won’t be the same degree of difficulty from an economic perspective but who knows? We’re all praying for a soft landing. But listen, we pumped $3 trillion in the economy. We’re crashing. And that’s something I expected; I knew this was going to happen. When you see home prices go up 70% in your neighborhood because money is cheap and now money’s not so cheap, the only thing keeping the economy afloat is a tight labor market. But if that changes, look out.

So, it’s important, listen, I hope no one has to take a hardship, okay? I hope no one ever has to pull money out of their IRA or 401(k), trust me. It doesn’t help anyone. But if you do, this is an important podcast to listen to you because there’s cost effective and smart ways to do it, okay? Hardships is one of them. Yes, sucks to say I have a hardship, but also sucks to pay the 10% additional tax for no reason. So, a lot of people don’t know these rules. So, it’s important to talk to your IRA custodian. If you’re a client of IRA Financial, talk to us. If you have a 401(k), talk to your plan administrator. There could be ways to get money out. A lot of times you go to your plan administrator and say, hey, I need money. And they may just give you the line, well sorry, you’re under 59 and a half and you’re currently employed. You can’t get the money out and then you could say, well what about the loan? We don’t have a loan. Okay. Hardship, safe harbor, immediate financial need, here are the hardship requirements. I satisfy that, whether it’s medical care, whether it’s principal residence, repairs, tuition, eviction, funeral, whatever it is, and financial immediate needs, I want the money, I’ll escape to 10%. Tax is tax, right? Some people don’t mind the tax because they say, hey, I’m in a low income year, maybe I got laid off. I need the money to live. My income is going to be low, so ordinary income tax isn’t a major problem or listen, my kid, God forbid, has medical bills and I need the money to pay the hospital, so really don’t care about tax. And if there’s an easy way to get it, without paying the 10% penalty, I’m going to do it okay? And that’s important in the 401(k) world, where you may be told you can’t have access to your money, that’s when you need to know the term hardship. And in the IRA, if you pull money out, rather than just taking a distribution, see if you can satisfy a hardship to get around the 10% penalty. Hey, 10% is 10%, right? You take $50K, that’s $5K. Take $100K, that’s $10K – adds up.

So, hope you guys enjoyed today’s podcast. I hope none of you ever have to do a hardship, but things happen. I remember ’08-’09. We were all there, and it was scary, and we all took hardships. So, it’s there, it’s there for these reasons, but you need to know the rules and that’s my job to educate you on the most cost effective way of pulling money out of an IRA or 401(k).

So, thanks for listening. If you’re watching on YouTube, appreciate it. Don’t forget to subscribe to our really great channel, where we drop three podcasts and three to four videos, plus a live that is generally each Wednesday, 12 Eastern, noon. But, if I go live on a different day or a different time, you’ll be notified. So, it’s free; subscribe! Why not? Other than that, have a wonderful day and talk to everyone again next week. Take care.