As Jobless Claims Mount, Laid-Off Workers Should Not Rush To Withdraw Retirement Savings

With job losses continuing to mount, tens of thousands of laid-off workers are now turning to their 401(k)'s, IRA accounts and other retirement savings to keep their families afloat. However, individuals considering a premature distribution from their retirement savings should be wary, know their options, and develop a strategy before withdrawing from these accounts. If they don't, they may find themselves subject to a larger than necessary tax burden.

Most individuals are aware that withdrawals from a qualified retirement account are not only taxable, but in most cases, subject to a 10% IRS Penalty if taken prior to age 59.5. Although a 10% penalty may seem inconsequential when you are in this situation, there are exceptions to the rule. Additionally, the timing and amounts of the withdrawals are also important as improper planning could subject most Americans to an even larger tax burden.

Let's address the two types of tax rules separately.

Income Tax

Any withdrawal from an IRA, 401(k) or any other qualified retirement account is subject to income taxes, just as if you had earned the money at a job. As a result, many middle class Americans who make withdrawals from such accounts later regret the decision when they realize that either their typical tax refund is gone or they owe taxes at the end of the year. So TIP #1 - If not mandatory, have sufficient taxes withheld.

Tip #2 - Understand our tax code. Let's assume that you and your spouse both work, with a typical adjusted gross income of around $65,000 (comparable to two $40,000/yr. jobs)($40,000 each). Now let's assume that you were laid off at the beginning of the year and it takes you 2 months to find a comparable (income) job. During that time, you withdrew $20,000 from your retirement accounts as you were fearful of how long you might be unemployed. Based upon your income, your family is in a 15% tax bracket. However, because of a rush to judgement in withdrawing a large sum from your retirement account, based upon you adjusted gross income, and the shortened lay-off period, you have now entered the 25% tax bracket. As a result, approximately $8,000-$9,000 of your withdrawal is actually being taxes at the 10% higher rate. The biggest mistake that many individuals losing their job make, is to immediately make large withdrawals or take a lump-sum distribution from their retirement plan.

Take the time to draw up a budget, determine how much you need and only take what you need. If you were terminated and have to make a decision regarding your retirement funds, then roll them into money market IRA with no fees until you are able to determine a if and when you might need to access the money.

Tip #3 - Understand that there are exceptions to the 10% penalty that you may qualify for. The IRS will allow you to withdraw money prior to age 59.5 without incurring the 10% penalty if...

1. The funds are used for qualified expenses incurred by first time home buyers. Up to $10,000 may be withdrawn without incurring the 10% penalty, so long as the funds are used within 120 days to buy, build or rebuild a "first" home.
2. Medical Expenses exceeding 7.5% of adjusted gross income.
3. Amounts needed to purchase health insurance if unemployment compensation has been received for at least 12 weeks.
4. Qualified education expenses including tuition, books, fees, supplies and equipment necessary for enrollment or attendance at a post-secondary school offer credits towards a Bachelor's or Master's degree.
5. Disability or Death

Tip #4 - For those forced from their job who were near retirement or have substantial retirement savings, the IRS has a rule that will allow you to receive an ongoing income from you IRA, prior to age 59.5 without incurring a 10% penalty.

The obscure rule, 72(t), allows individuals to avoid the 10% penalty by taking distributions in a series of substantially equal periodic payments (made at least annually) over the life of the owner or joint life of the owner and beneficiary. The IRS, has three formula's that can be used to determine the amount of income that you receive from the IRA to allow some control over your income. In addition, the income must be received for a period of at least 5 years or until the age of 59.5, whichever is longer. This option, which few individuals know of, can provide your family with an ongoing income without worrying about excess taxation and could be a sound option for those Americans who find themselves just a few years away from retirement and unemployed.

In order to avoid the penalty, owner must be clearly understand the provisions of the rule and should talk to their qualified tax accountant, attorney or financial advisor for help in determining whether or not 72(t) distributions are an option for them. These professionals, along with investment companies can help you comply with the law by running the amortization tables and finding financial companies that offer the option to their clients.

The bottom line of this article is that nationwide hundreds of thousands of workers are finding themselves in a horrible position. Whether you worked for a large company such as Caterpillar in Decatur or Peoria Illinois, or a small company in California, you are all in a scary position. Too often, financial stress can lead to poor decisions in regards to retirement savings, and the simple step of understanding your options and taking the time to develop a strategy can save you thousands or even tens of thousands of dollars in excess taxes incurred by taking an early withdrawal. Talk to a professional, understand the options and make sure that they are listening rather than just trying to sell you. Doing so can help reduce your stress today, and potentially save you from regrets tomorrow.

There is no way to avoid taxation on withdrawals from retirement accounts, but at the same time there is no sense in paying the government more than they are entitled too. I'm sure that you will make wiser decisions with your money, than they would.

Information Guest Post Provided By HCM Financial

This article is for informational purposes only and in no way should be considered investment or tax advice. Please consult your qualified tax professional, attorney, or financial professional for advice.

If you live in Illinois or Indiana and would like to receive complimentary information concerning your retirement distribution options, please contact our friends at HCM Financial. They will mail or email you information with no fees, without obligation, and with no sales pitch.

Click Here To Request Information Concerning 72(t) or IRA Distribution Options