Read This First Before Tapping Your Retirement Savings
Your 401(k), IRA or other retirement accounts may be a tempting source for cash if you find yourself short of funds or have a major purchase you are considering. But withdrawing money from a traditional IRA or qualified retirement account before you reach age 59 1/2 may not be the best idea, as you will likely pay both income tax and a 10% early-distribution tax (also referred to as a penalty) on any previously untaxed money that you take out.
Withdrawals you make from a SIMPLE IRA before age 59 1/2, and those you make during the 2-year rollover restriction period after establishing the SIMPLE IRA, may be subject to a 25% additional early-distribution tax instead of the normal 10%. The 2-year period is measured from the first day that contributions are deposited.
These penalties are just what you’d pay on your federal return; your state may also charge an early-withdrawal penalty in addition to the regular state income tax.
Thus, before making any withdrawals from a traditional IRA or other retirement plans, including a 401(k) plan, a 403(b) tax-sheltered annuity plan, or a self-employed retirement plan, there are two things you should carefully consider: (1) you are taking funds, and their future appreciation, from your retirement savings which can impact your future retirement lifestyle. (2) You will be creating unnecessary taxes and penalties which will increase the amount you will need to withdraw to obtain your needed funds.
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As part of the CARES Act, the requirement for older taxpayers to take required minimum distributions (RMDs) from their retirement plans was waived for 2020. This primarily was due to the anticipated drop in value for most investments as a result of the economic effects of COVID-19, which actually did not materialize.
Advance planning can, in many cases, minimize or even avoid taxes on IRA distributions and other qualified plan distributions. When contemplating future retirement and when to begin tapping taxable IRA and other qualified retirement accounts, taxpayers need to consider a number of important issues.
Keeping your designated IRA beneficiary current is very important. You may not want your account going to your ex-spouse, and you certainly do not want a deceased individual to be your beneficiary.
The tax code offers two types of IRAs; one is referred to as the traditional individual retirement account (IRA), so named because it was the first type of IRA available, having been created by Congress back in the 1970s. The second type is the Roth IRA, established in 1997 and named after William Roth, who was a senator from Delaware. Which one is best for you?
If you are suddenly in need of a substantial amount of cash, probably the last thing you should do is tap your retirement funds. They are the key to a financially comfortable retirement. The younger you are, the less likely you are to think about saving for retirement, but you certainly don’t want to end up living off of only Social Security. However, there are times when there might not be any other alternative than dipping into your 401(k), IRA or other retirement plan. In that case, you have to be concerned not only with any tax liability, but also early withdrawal penalties if the funds are withdrawn before reaching age 59 1/2 Plus, some distributions may only be partially taxable and some not taxable at all, while others are fully taxable.
Tax law permits you to take a distribution from your IRA account, and as long as you return the distribution to your IRA within 60 days, there are no tax ramifications. However, many taxpayers overlook that you are only allowed to do that once in a 12-month period, and violating this rule can have some nasty and unexpected tax ramifications. 
If you have an IRA account or are considering one, there are a number of potential missteps you will want to avoid. Some of them can lead to unwanted taxes and penalties, and of course, we are talking about your retirement funding, so it is an important issue. Here are a number of issues to keep in mind: