By LouAnn Schulfer, AWMA®, AIF®
Accredited Wealth Management Advisor^SM
Accredited Investment Fiduciary®

Taking distributions is usually the ultimate reason that people build retirement savings:  at some point, you’d like to turn your nest egg into income.  Just as there are rules on when, how and how much you can contribute, there are also rules on taking money out of Individual Retirement Accounts and retirement plans, such as your 401(k).  It is important to note that while IRAs and 401(k)s have some rules in common, there are also rules which differ between the two.

Many people are aware of the federal and state premature distribution penalties imposed if they withdraw money from an IRA prior to age 59 ½.  There are some exceptions to this rule, such as if the money is used for education expenses for the account owner’s family.  Exceptions also may apply in the event of the account owner’s disability, a first time home purchase, or an IRS section 72(t) distribution arrangement, which is a series of substantial equal periodic payments at least annually until the account owner turns 59 ½ and they have taken payments for at least five years.  However, the overlooked mistake with an early withdrawal is the lost opportunity for years of potential compounded tax-deferred growth.  Since there are rules for how much money you can put into a retirement account each year, if you take a large withdrawal, you may not be able to get that money back in your retirement savings.  Retirement accounts offer a unique opportunity in that you can choose from a wide variety of investments AND benefit from potential tax-deferred growth.  If you choose those same investments outside of your retirement account, you will be subject to taxation in years that there is taxable growth in the account, as reported on your 1099.  It’s like the difference between a snowball rolling and growing in size year after year, versus a snowball rolling, growing, then melting a little each year before it starts it’s path to growth again.

When you separate from your employer, you generally have four options with your employer sponsored retirement plan.  You may leave the money in the plan if permitted, cash the retirement savings out, roll the money over to an IRA, or transfer the money to your new employer’s plan if they allow.  I’ve had a couple of clients retire this year at age 55.  We were sure to carefully draft their retirement income plan, paying particular attention to where they were going to get their income from in the years between ages 55 and 59 ½.  Money withdrawn from an IRA prior to age 59 ½ is subject to premature distribution penalties:  10% federal and an additional Wisconsin state penalty that equates to 33% of the federal penalty.  Here is one of those instances where there is a difference between IRAs and employer plans:  money withdrawn from the employer plan is not subject to premature distribution penalties if you retire in the year you turn 55 or after, and you must be withdrawing the money from the employer’s plan in which you’ve retired from.  Leaving enough money in the employer’s plan allowed these happy new retirees to begin retirement income payments subject only to ordinary income taxation.  Had they rolled their entire balance into an IRA, they would have been subject to the costly premature distribution penalty mistake.

The examples above are not an exhaustive list of exceptions.  You may visit irs.gov and revenue.wi.gov for more information.  Knowing the rules can help you avoid common and costly IRA mistakes.  Knowing the rules can also open up opportunity, such as retiring earlier than you may have you thought you could.

LouAnn Schulfer is co-owner of Schulfer & Associates, LLC Wealth Management and can be reached at (715) 343-9600 or louann.schulfer@lpl.com.  www.SchulferAndAssociates.com

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

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