Losing your job is a stressful time, but don’t bury your head in the sand. You need to get moving, not only to find another job but to make sure your family is provided for and your obligations are paid. You may be tempted to draw on your retirement savings, but that can have severe tax consequences as well as reducing the stability of your future. Here are some common retirement-related tax questions that people ask after losing a job.
The tax benefits of IRAs and qualified retirement plans rely on the fact that you will not use the money until you reach retirement age, defined as 59½ by the IRS. Therefore, if you take the money out before then and you do not roll the money over into another acceptable plan within 60 days, it will be considered taxable income in the year that it was taken out of the plan, plus an additional 10% penalty, plus you may also be liable for state taxes and withholding. Of course, there is the hidden tax: losing the tax-deferred growth you would have had.
If you fall under certain hardship guidelines, you can take money from your retirement plan without penalty. However, you must make sure to follow the IRS’s guidelines for hardship withdrawals. These include permanent disability or withdrawals used to pay medical expenses that exceed 7.5% of your adjusted gross income. IRS Publication 575 has more information.
If you need to withdraw a contribution you made in the same tax year, you can do so without penalty as long as you also take any interest or dividend that goes with it. However, you may not take a deduction for this contribution, and any interest or dividends count as income.
The IRS allows you to move (or, “rollover”) the funds from one plan to another without penalty or taxes, as long as you deposit the funds within 60 days of the withdrawal.
When you made non-deductible IRA contributions, you should have filled out Form 8606 to establish the cost basis in your combined IRAs. Publication 590-B offers a worksheet you can use to calculate which part of the distribution is taxable. Attach the worksheet and Form 8606 with Part I completed to your tax return.
It is common and straight-forward to roll over your pension distribution to a financial institution, such as a bank, credit union, or brokerage house, and it is not taxable if you complete the rollover within 60 days. However, there are some restrictions on both you and the financial institution, such as not borrowing the distribution, even if you sign a contract charging interest, unreasonable compensation cannot be charged for managing the funds, and you may not use the distribution to buy property for personal use or use the distribution as security for a loan. Publications 575 and 590 offer additional information.
Most people rely on their company-sponsored retirement account for retirement savings. After a job you most likely will not be able to contribute to this anymore. If you still want to make contributions on a monthly basis to a retirement account even after you have lost a job it is still possible. If you have extra cash-on-hand that you want to get tax savings on you can do this through an IRA. The most common types of IRAs are traditional IRAs and Roth IRAs.
Losing your job is stressful enough, so make sure you know all the tax rules that pertain to your retirement plan. If you have additional retirement tax questions, consult your tax professional or CPA.
This post was published on March 8, 2012