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Four times it's okay to dip into your retirement fund early

 
Published May 9, 2016

Taking an early withdrawal from your 401(k) is not only costly in the short term, it can also jeopardize your long-term retirement goals. If you withdraw retirement accounts before the penalty-free 401(k) withdrawal age of 591/2, you'll be forfeiting the benefits of tax-deferred earnings and compounding interest.

Because of the severe financial penalties, withdrawing money early from retirement accounts should be done only in extreme emergencies, ideally after any emergency funds and investments have been depleted.

If you are in a financial pinch and considering taking money out of your 401(k) or any other retirement savings account, here are four times it's okay to dip into your retirement fund early.

YOU BECOME TOTALLY AND PERMANENTLY DISABLED: You can take penalty-free distributions from qualified plans due to a total or permanent disability. Minor or partial disabilities don't qualify.

According to the IRS, you are considered disabled if:

• You can provide proof that you cannot do any substantial gainful activity because of your physical or mental condition.

• A physician determines that your condition can be expected to result in death or to be of long, continued and indefinite duration.

Some experts recommend first applying for state disability insurance to make it easier to prove your status to the retirement plan administrator. To take a 401(k) hardship withdrawal, you must fill out IRS Form 5329 to get out of paying the penalty and ensure you are adhering to IRS 401(k) loan rules.

YOU'RE DROWNING IN MEDICAL DEBT: You can withdraw from your retirement accounts to cover unreimbursed, out-of-pocket medical expenses that exceed 10 percent of your adjusted gross income. These expenses must be paid in the same year you take the distribution, and the distribution is not subject to penalty of tax if withdrawn from an IRA.

The difference between these expenses and 10 percent of your AGI is eligible for this exception.

YOU'RE GETTING DIVORCED: If you get divorced, you might be required by a court to divide the funds with your former spouse or a dependent. These distributions are usually ordered under a property settlement under a qualifying domestic relations order and are exempt from an IRA or 401(k) withdrawal penalty.

YOU'RE STARTING A BUSINESS: You might be able to use your 401(k) and IRA funds to finance a small business or startup. This process isn't simple, and there are significant legal steps you will need to take, including rolling the money over into a corporate retirement account that allows you to invest in the business.

For some entrepreneurs, this move has been well worth the effort and extra risk. Jason Fisher, the owner and founder of Waterway Financial Group, which provides holistic financial planning, drained his 401(k) to start his small business.

"I tapped out my entire 401(k) to begin a small business," Fisher said. "While it wasn't a ton of money, it was crucial for my business to have as much capital up front as possible, and the hit I took in penalties and taxes was well worth it."