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To Tap Your IRA or Not? That's the Question

A new study says there's been a run on these retirement accounts. Here's what to know before you withdraw any money.

posted by Richard Eisenberg, June 13, 2013 More by this author

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Richard Eisenberg is the senior Web editor of the Money & Security and Work & Purpose channels of Next Avenue and Assistant Managing Editor for the site. Follow him on Twitter @richeis315.


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In a classic 1978 Doonesbury comic strip, Duke (modeled after Hunter S. Thompson) says, “But the pension fund was just sitting there!”

Duke was justifying why he tapped into the money to finance hiring a Samoan for the football team he was coaching.
 
But I think Duke’s quote is pretty apt in describing the huge number of people pulling money out of their Individual Retirement Accounts, according to a new Employee Benefit Research Institute (EBRI) study.

(MORE: Tap Into an IRA for Post-Retirement Cash)

I first thought the trend was extremely troubling, but I’ve had second thoughts.
 
Who’s Making IRA Withdrawals
 
Sudipto Banerjee, an EBRI research associate, just reviewed data on the 12,347 U.S. retired households age 61 to 80 that made an IRA withdrawal between 2002 and 2010. I was particularly interested in IRA withdrawals made by retirees 61 to 70, since you’re required by law to take money out of a traditional IRA (not a Roth IRA) annually beginning at age 70½.
 
Banerjee calls IRA distributions before age 70½ “early withdrawals,” although I’ve long believed that early withdrawals from IRAs are ones made before you’re 59½, since you’re generally hit with a 10 percent tax penalty on them. (You will, however, owe taxes on withdrawals from a traditional IRA at any age.)
 
Key Findings From the IRA Study
 
Here are the highlights for the retired households age 61 to 70:
  • 48 percent of the lowest-income households made an IRA withdrawal.
  • The lowest-income households withdrew 17 percent of their IRA balance annually.
  • 29 percent of the highest-income households made an IRA withdrawal.
  • The highest-income households withdrew 12 percent of their IRA balance annually.
  • The average withdrawal was $16,655 (much higher than the $10,557 average withdrawal for people 71-80).
  • 58 percent spent the IRA withdrawals for “regular expenses.”
  • 26 percent spent the IRA withdrawals for “special purposes” (the survey didn’t define “special,” but Banerjee thinks it means such purchases as expensive cars, not medical bills).
 
What Concerns the Study’s Author
 
I asked Banerjee what he made of these results.
 
“The main thing that stands out for me is that many of the people age 61 to 70, especially in the lower income brackets, are withdrawing money from their IRAs at a very fast rate,” he said. “The 17 percent withdrawal rate was definitely surprising.”
 
(MORE: Required Annual Withdrawals From Retirement Plans)

“It’s a cause for concern for those in the lower-income group because they might run out of money – at least money in their IRAs – very soon.”
 
He’s also troubled about what people are doing with the IRA distributions. “It’s not going into any other form of savings,” Banerjee said. “These people are spending the money.”
 
Breaking into 401(k)s Early
 
Banerjee’s study reminded me of another one I wrote about a few months ago. In that one, the financial advisory firm HelloWallet revealed that 1 in 4 401(k) participants are breaking into their employer-sponsored retirement accounts to use the money for financial emergencies and other purposes.
 
The one difference, though, is that the IRA report was of retirees, who are at the stage when it’s sensible to tap into their retirement accounts, while the 401(k) one was of employees still squirreling money away for when they’ll stop working full time.
 
Why One Money Pro Isn’t Troubled
 
This distinction is the reason Dee Lee, a Boston-based certified financial planner and financial educator, isn’t tearing her hair out about the IRA withdrawal findings – and why she persuaded me not to, either.
 
“It always worries me when people are pulling money out of their retirement plans, but that’s what they’ve saved for,” she said. “The boomers look at the money and say: ‘I don’t know how long I’ve got left; some of my friends are dying off.’ So they then say: ‘I’m going to spend it.’”
 
(MORE: How to Make Your Retirement Money Last)
 
What’s more, Lee said, the study doesn’t specify exactly what the IRA withdrawals were spent on. The purchases could have been essential, frivolous or something in between.
 
“Were they using the money to take a two-week cruise down the Danube costing $9,000?,” Lee said. “Or because the roof needed fixing after a hurricane? Or for their grandkids’ education? We really don’t know.”
 
When an IRA Withdrawal Can Be Wise
 
Banerjee also noted that it can actually be beneficial to withdraw some IRA money after 59½ (when the 10 percent tax penalty is no longer an issue).
 
The key, he said, is to use the cash so you can postpone claiming Social Security for a few years. Social Security checks are 8 percent larger each year you delay claiming your benefit between your full retirement age (65 to 67, depending on when you were born) and age 70.
 
“For example, if you retire at 65 but don’t take Social Security until you’re 70 and you use your IRA to support yourself between age 65 and 70, you’ll be maximizing your Social Security benefit for the rest of your life,” Banerjee said.
 
But he doubts many people withdrawing from their IRAs in their late 60s are employing this Social Security strategy. “My guess would be that very few are,” he said.
 
How to Avoid the IRA 10 Percent Tax Penalty
 
If you do feel a need to pull money out of your IRA, there are a few ways to do so before 59½ without incurring the 10 percent tax penalty. An excellent Forbes article by Janet Novack describes 11 of them, but let me call out four:
 
Making “substantially equal periodic payments” from your IRA. You have to keep making the withdrawals for five years or until you’re 59½, whichever comes later. These are known in the financial planning trade as Rule 72(t) withdrawals, Lee said, named for the portion of the tax code describing them. The Bankrate site has a nifty calculator to help you figure out how much to withdraw.
 
Paying for out-of pocket medical expenses exceeding 10 percent of your adjusted gross income. That figure is up from 7½ percent last year.
 
Paying for college. The money could be used to educate yourself, your child or your grandchild.
 
Paying for health insurance if you’re unemployed. You’ll need to be on unemployment insurance for a minimum of 12 weeks to qualify for this penalty exemption, though.
 
The Best Strategy for Your IRA
 
So if you have to get into your IRA before retirement or you’re retired and need to tap into the funds to cover expenses, do what you must.
 
That said, keep in mind Lee’s advice: “The best strategy is to leave the money in your tax-deferred accounts for as long as you can.”