In preparation for retirement, it is highly advisable to create a retirement savings plan. This is a plan that outlines how you will manage your finances once you stop working regularly and stop drawing a regular work paycheck or salary.
In many cases, this involves the creation and maintenance of a retirement savings account. This is often called an “individual retirement account,” or IRA. IRAs can be created and managed through many means, including financial institutions, as well as through the person’s employer.
Retirement savings can have many advantages, and can help a person wisely set aside their money for use when they retire. On the other hand, they can often be associated with various restrictions and limitations regarding how and when the retirement money can be used.
What are the Different Types of IRAs?
Generally speaking, there are two main types of IRAs. These are:
- Traditional IRAs: These types of IRAs allow you to contribute a certain amount each year and invest your contributions without being taxed on the annual investment gains. This helps you grow more funds over time.
- This tax break provides an immediate advantage; however at retirement it is typically only beneficial if the holder is in a lower tax bracket.
- Also, withdrawals cannot begin until age 59 ½ or a 10% fee is charged.
- Lastly, once withdrawals begin there is a minimum annual withdrawal.
- Roth IRAs: With these types of IRAs, contributions are made after being taxed. On the other hand, withdrawals are made free from income tax, including most earnings from the account. There are also fewer restrictions and requirements on withdrawals compared with traditional IRAs.
The choice of whether to use a traditional IRA, Roth IRA, or other type of retirement savings mechanisms generally depends on your aims and goals. Depending on your exact situation, one type of savings account might be more beneficial for you. You may need to speak with an attorney for more advice on how to select the account that is right for your needs.
What Happens if I Withdraw From Retirement Savings Before Retirement?
As mentioned, with a traditional IRA, a withdrawal made before you are 59½ years old from your retirement savings plan is considered to be an early withdrawal. This is true “whether it is an IRA or a qualified plan through an employer. Also, for every early withdrawal you make, you will have to pay a 10% early distribution tax to the federal government.
Thus, these are some aspects of financial planning that you should consider when planning your retirement. It is best to discuss these aspects with a financial planning expert, like an accountant or a specialist.
Can I Make Early Withdrawals Without Paying 10% Tax?
Generally, you will not want to start withdrawing from your retirement savings early unless there are dire circumstances that demand otherwise. There are however a few exceptions that allow you to start making early withdrawals without facing the 10% tax. These may include:
- If you take distributions from your account in equal annual (yearly) installments, and those installments are designed to spread out over your entire life, you will most likely not have to pay the early distribution tax.
- Note: If you decide to choose this option with an employer’s retirement plan, you can only elect to do it if you are no longer employed there. With an IRA however, your employment status does not matter.
- If you decide to retire when you are at least 55 years old, you can take distributions from your employer’s retirement plan. This can happen once you quit work without suffering any early distribution tax.
- You do not even have to stay retired either; you may work for another employer and still take distributions from your former employer’s retirement plan.
- The only rule to remember is that you cannot be working for the same employer whose retirement plan you are taking the distributions from.
- Some employers offer employer stock ownership plans (ESOP). These are similar to a pension plan except that an employee may receive distributions in stock rather than cash (though not always).
- However, the dividends received from the ESOP stock are not subject to the early distribution tax.
- In terms of distribution going to your beneficiaries, once you have died, your beneficiaries can receive distributions from your account without being subject to the early distribution tax.
- This can happen AS LONG AS your account is rolled into your beneficiary’s account; and
- If you become permanently disabled ( it must be permanent to qualify), you may receive distributions from your retirement plan without having to pay the early distribution tax
As you can see, there are a great number of considerations and details associated with retirement planning. You may need to consult with a lawyer for assistance with any specific questions or concerns you may have.
Should I Hire a Lawyer for Help with any Retirement Legal Issues?
Make sure that you read over any forms you received when you opened your retirement account. These forms can explain how the retirement account works, including what taxes are applied and when. If you have an employment plan, you may want to ask your employer for more information about the tax implications and benefits.
Finally, you may want to consult with an elder law attorney in your area for help understanding how you contributions to and distributions from the account are taxed. Your attorney can help you understand when and how your earnings are taxed, and can also help you choose what kind of retirement plan may be best suited for your needs.