Find Out First: Early Withdrawal Penalties May Not Apply

Most of us are mindful about following the rules to avoid unnecessary penalties for savings and investment accounts with early withdrawal penalties. We might be missing out on some opportunities, says CNBC’s article, “Sometimes, early withdrawal penalties don't apply.” There are situations where the penalty may not apply to you, or the benefits of the withdrawal outweigh the penalty. Read the fine print, so that you know what the penalties are, and then do an analysis, instead of assuming an early withdrawal will become too costly. Just be mindful of what you are doing and don’t take money you are saving for retirement unnecessarily.

Certificates of Deposit. If your CDs are growing at less than 1% a year at a bank, but the bank across the street is offering annual returns of 1.72% on their certificates of deposit, you might consider an early withdrawal, despite a penalty of three months interest. Do the math: you might be ahead financially after three months, at the other bank's higher interest rate.

529 Plans. There's no early withdrawal from a 529 plan—the tax-advantaged account that can be used for education-related expenses. That’s because there are no rules as to when you can use the money. The rules stipulate only what you can use it for, which is just education-related expenses. There’s a penalty if you use it for other reasons. It’s a 10% tax penalty, as well as income taxes on the account's earnings. In many cases, the family’s no worse off than they'd be in a taxable account.  However, you may have to repay the state income tax benefits you received for using the account. If your child does plan on going to college, the withdrawals will leave your savings with less time to compound.

Retirement savings. An early withdrawal from your retirement account is a huge black eye in personal finance. Using an individual retirement account (IRA) or 401(k) plan before the age of 59½ can mean a 10% penalty, income taxes, and a depleted fund for your retirement. There are several exceptions to the 10% penalty, eliminating that expense when you withdraw early from your retirement account. However, there's confusion about when the penalty does and does not apply. For example, if you decide to retire at 56, you can withdraw from your 401(k) without any penalty. However, if you roll it into an IRA, you'd have to wait until 59½ to have your money without consequences.

If the money is being used for serious medical expenses, or if there’s a medically documented disability, or death, penalties may be waived for 401(k) plans or IRAs. Using the funds to pay for health insurance while you’re unemployed is also permitted, and there are also rules for divorce. Check with the financial institution for each account.

Reference: CNBC (August 21, 2018) “Sometimes, early withdrawal penalties don't apply”

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