During times of financial need, some people are tempted to cash out individual retirement accounts, also known as IRAs. In general, an IRA is meant to be held until the age of 60, but it can legally be cashed out during times of financial stress. Cashing out an IRA can provide access to a lump sum of money, but may also require a waiting period and trigger tax penalties and early withdrawal fees.
Consumers may cash out an IRA early for a variety of reasons, but usually they need a lump sum of cash. They may need this cash to purchase a home, pay for educational expenses, or cover large medical bills. In fact, it may be possible to avoid tax penalties in some cases by using the funds from an IRA for these purposes.
Another pro of cashing out an IRA before the age of 60 is that a portion of the entire retirement fund can be retained for later use. An individual can cash out a portion of the IRA funds and then build this income back up by contributing to this plan over time. That means the funds that remain in the IRA will still accrue earnings so long as the invested funds earn a return during economic upswings.
A common pitfall of cashing our an IRA before the approved distribution age of 59 ½, is that the funds will be subjected to an initial 10% taxation by the government. This distribution is considered income by the IRS, therefore it must be reported as income and must be taxed. At tax time, this income must then again be reported and additional taxes may be levied, depending on the income level of the filer. For some taxpayers, the benefits of having access to cash outweigh this tax requirement.
Another con of cashing out an IRA early is that it will be subject to an early withdrawal fee by the plan administrator. Generally, this fee is 15% to 20% of the total distributed fund limit. This can mean a cash distribution of $10,000 US Dollars (USD) will be reduced by as much as $1,500 to $2,000 USD by the time monies reach the participant. Therefore, it is important to decide if this reduction is worth it before cashing out all or some of the IRA. There may be other ways to raise capital instead of cashing out an IRA.
A possible negative of cashing out an IRA is the waiting period established by the retirement plan administrator. When money is needed in a hurry, it is inconvenient to wait the ten to 14 days that many plan administrators require. This waiting period ensures that all funds are credited to the individual, and that the employment and identity are verified before cutting am IRA disbursement check.