What Are the Rules for Taking Money Out of Tax-Deferred Retirement Accounts?

Many of us think of retirement as part of the natural order of things. Not long ago, this meant working until you’re about the age of 65, then living off a pension and Social Security benefits. Now, pensions have become less common, and the prospect of living into your 90s or longer has become more realistic, prompting many people to look at retirement differently.

For those who retire, whether earlier or later in their lives, the realities of that first Monday morning without a job – and a regular paycheck – can be unsettling. Nowadays, many need to tap into retirement accounts to maintain the lifestyle they always enjoyed. Many don’t always realize that there are strict rules on when you can (and must) begin withdrawing funds from tax-deferred retirement accounts (including IRAs, 401(k) plans, Thrift Savings Plans, 403(b) plans, and similar plans. Here are some of the basic rules, which changed significantly in recent years with the SECURE Act and SECURE 2.0 Act, and how they affect different types of withdrawals:

• Emergency Withdrawals: Beginning in 2024, under the SECURE 2.0 Act, you are now allowed to take an early “emergency” distribution from your retirement account to cover unforeseeable or immediate financial needs. That emergency distribution of up to $1,000 can only be taken once during the year and won’t be subject to the usual additional 10 percent tax that applies to early distributions. However, if you choose not to repay the distribution within a certain time, you won’t be allowed to take other emergency distributions for three years.
  • Other hardship withdrawals are provided for in the SECURE 2.0 Act including 403(b) plans. (Currently, distribution rules for 403(b) and 401(k) plans are different, so SECURE 2.0 would conform to those rules.)
  • Also, under SECURE 2.0, penalty-free withdrawals, on small amounts of money from retirement plans in cases involving domestic abuse, will be allowed.
  • Keep in mind that you will pay taxes on whatever you saved in tax-deferred accounts when you take it out. That additional income could then put you into a higher tax bracket. This is why Roth IRAs can be helpful, as you pay no tax on whatever you withdraw after age 59 1/2.
  • Also, even though it’s permissible for you to spend retirement funds starting at 59 1/2, you don’t have to do so.
  • Withdrawal penalties are a form of excise tax. Withdrawals you make before you reach age 59 1/2 are subject to a 10 percent excise tax (with limited exceptions). In other words, you pay the government 10 percent of the amount withdrawn plus the taxes that are otherwise due upon withdrawal.

• Non-Penalized Withdrawals: Most retirement accounts allow you to start taking penalty-free withdrawals when you turn 59 ½. If you need access to your funds before then, you can make an early withdrawal, but you’ll generally incur an additional 10 percent early withdrawal tax penalty unless an exception applies as mentioned above.

• Mandatory Withdrawals:
  • Required Minimum Distributions (RMDs): Retirement withdrawals are mandatory when you reach a certain age. By law, you must now take your first RMD by April of the year after you turn 73. (If you were age 70 1/2 before the end of 2019, you had to begin distributions at 70 1/2.) Individuals are responsible for knowing how much to withdraw as part of these required minimum distributions. Here are some things you should know about RMDs:
    • Under the law before SECURE 2.0, you generally had to take RMDs from your retirement plan beginning at age 72. SECURE 2.0 increased the required minimum distribution age to 73 as of January 1, 2023. In 2033, the required minimum distribution age will increase again, to age 75, but only for individuals who turn 74 after December 31, 2032.
    • You must begin taking distributions by April 1 in the year after you reach age 73. If not, you’ll pay a 25 percent excise tax (penalty) on the amount you should have withdrawn but did not. (If you correct this mistake within two years, you may be able to reduce your penalty to 10 percent). Before the SECURE Act, the penalty for failure to take required minimum distributions was 50 percent of the amount that you were required to take.
    • For seniors struggling to keep track of their finances, especially elders with Alzheimer’s and other types of dementia, forgetting to take required minimum distributions is unfortunately a fairly common occurrence.
  • The funds you withdraw from retirement accounts are always 100 percent taxable income in the year you take the distribution.
• RMD Rule for Inherited IRAs. 
  • When your children withdraw funds from a tax-deferred account they inherit from you, which they generally must do within 10 years after your death, they will owe income tax on these funds at their income tax rates.
• RMDs and Roth 401(k)s. Before the SECURE 2.0 Act, while Roth IRAs had no RMDs during the original account owner’s life, that wasn’t the case for Roth 401(k)s.
  • Beginning this year (2024), the SECURE 2.0 Act eliminates RMDs for qualified employer Roth plan accounts. So, owners of these Roth 401(k) accounts no longer have to take RMDs.
  • This change aligns Roth 401(k)s more closely with Roth IRAs.

Tips for Making the Most of Your Money in Retirement

It’s important to know the rules for early withdrawals and RMDs that are described above. It is also critical to know what you should and should not do to get the most out of your money. Below are some things you should try NOT to do:

• Withdrawing from Your 401(k) and IRA Before RMDs Kick In: You can start withdrawing money from your 401(k) when you turn 59 ½, but that doesn’t mean it’s a good idea. The law doesn’t require you to start taking Required Minimum Distributions until at least age 72, as explained above, so this is time your money can keep growing with compound interest.
• Plan Ahead to Make the Most Out of Your Money in Retirement: If you’re worried about your retirement, the best thing you can do is to plan! Work with an experienced financial advisor, such as myself and my affiliated financial advisors, to help you work through different scenarios and how they would affect your future retirement plans.

Planning for Retirement

Whether your retirement is coming up soon or is many years away, it is important to protect your hard work and your golden years with effective retirement planning and long-term care financial planning.

Besides being a Certified Elder Law Attorney, I am also an experienced retirement planning advisor and long-term care financial advisor through my affiliation with Protection Point Advisors.

Retirement planners, such as myself, generally work with people ages 55 and older who are within 10 to 20 years or so of their desired retirement age.

If you have not done your Estate Planning or retirement planning or had your planning documents and retirement plan reviewed lately, please call us for an initial consultation or a free annual review for members of our Lifetime Protection Plan®.

To get started on retirement planning, Estate Planning, or Long-Term Care Planning, please contact us to make an appointment:

Northern Virginia Retirement Planning: 703-691-1888
Fredericksburg, VA Elder Law: 540-479-1435
Rockville, MD Elder Care: 301-519-8041
Washington, DC Estate Planning: 202-587-2797