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When It's Smart -- if Ever -- to Tap Your Retirement Accounts

Teresa Mears

Money is really tight, and you're struggling just to get by. Then you remember that you've got tens of thousands of dollars in your retirement accounts. Can't you somehow get access to that cash?

The short answer is yes. But should you? Probably not.

"If they're going to do so, they really should be aware of the tax consequences," says Jamie Hopkins, a professor of taxation at the American College in Bryn Mawr, Pennsylvania, and the associate director of the New York Life Center for Retirement Income. You face more than taxes and tax penalties. You lose not only the money you withdrew but also the money it would have earned, which is a substantial amount calculated over years.

Each type of retirement account has slightly different rules. It's usually possible to withdraw money from an IRA, though not always from a 401(k). But any withdrawal -- with some exceptions detailed below -- carries a 10 percent tax penalty unless you're at least 59 1/2. Plus, you'll have to pay income tax on whatever you withdraw. That means that if you withdraw $100,000 and you're in the 25 percent tax bracket, you'll need to send $35,000 to the IRS: $25,000 in tax and $10,000 in penalties.

There are times that you have no choice. But most of the time, finding the money elsewhere is the better choice.

"In a perfect world, we would recommend as much as possible that you don't tap any retirement accounts," says Ben Barzideh, a wealth advisor at Piershale Financial Group in suburban Chicago. "Your retirement account is intended to be for retirement."

[Read: 11 Ways to Avoid the IRA Early Withdrawal Penalty.]

If you have a 401(k), you may have a better option: If your plan allows it, you can borrow up to half your balance or $50,000, whichever is less, and pay it back over five years, essentially paying interest to yourself. With a loan, you don't incur any tax liability and you don't pay any penalties. But if you leave your job, you have to pay off the loan in full.

"Loans can satisfy a lot of people's needs without the penalties," Hopkins says. "That's really the best way for most people to go."

The IRS rules for early withdrawal vary slightly for IRAs and 401(k)s -- and 401(k) plan administrators may add their own rules. Other types of defined benefit plans have specific rules as well. But you usually have to be 59 1/2 to withdraw funds from either type of account without penalty, unless your withdrawal meets certain criteria. Know that even if you're able to avoid the 10 percent penalty, you will still have to pay income tax on the money you withdraw.

Roth IRAs, which are funded with money on which you've already paid income tax, have different rules. If you have a Roth, you can withdraw all the funds you have contributed (but not your earnings) without tax or penalty at any time.

Even when you can withdraw from an IRA without penalty, it may not be a good idea. For example, you can withdraw money from a traditional IRA without penalty to pay qualified education expenses for yourself, your spouse, your child or your grandchild. It may make more financial sense for your college student to take out loans than for you to dig into your retirement savings.

"You do not want to sacrifice your retirement to send your child to college," Barzideh says.

Switching jobs is another place where mistakes are common. A number of people take money from their 401(k)s when they leave their jobs, incurring taxes and penalties. But the better course is to roll that money over into an IRA, where it can continue to grow and fund your retirement.

[Read: 4 Questions to Ask Before Borrowing from Your 401(k).]

Beyond the taxes and penalties you incur when you take early withdrawals from a retirement account is the loss on the money you might have made. That means early withdrawal is even more expensive when you're young. Fidelity Investments calculated one hypothetical scenario: Take the $5,500 you put into your 401(k) in cash when you leave your job, and you've given up $58,721 when you retire 35 years later, assuming a 7 percent rate of return. (Taxes, fees and penalties were not part of the calculation.)

"Tax-deferred money grows faster," Hopkins says. "If you're really young, you're actually giving up more. You're giving up a lot of growth."

Taking money out of your retirement account to pay your mortgage might make sense -- if you're in a short-term crunch. But if you don't see any way to earn enough to make your payments in the foreseeable future, you may be better off selling the house and hanging on to your nest egg. Some of the saddest stories of the recent recession and real estate bust were about homeowners who drained their retirement accounts to pay their mortgages and then lost their homes anyway.

Entrepreneurs sometimes use their IRA money to start a business. That's great if your business makes millions, but "if that business fails, your retirement is gone as well," Barzideh says.

Withdrawing funds to pay credit card debt also is probably not smart. While the taxes and the penalty may seem like less than the interest rate you're paying on some credit cards, using retirement funds to pay off debt may be more costly in the long run, especially if you run up new debt.

You can withdraw money from your IRA without paying taxes and penalties as long as you put it back within 60 days. But if something happens and you can't pay it back, you're stuck with penalties and interest.

The rules for hardship withdrawals, like all IRS rules, are complex, so you may want to consult with an accountant or financial advisor before doing anything.

[See: 7 Tips to Help Millennials Save for Retirement.]

Here are seven instances in which you can withdraw funds from an IRA or 401(k) without paying penalties. Remember that you will still have to pay income tax on any money you take out.

Buy a house. You can take out up to $10,000 from an IRA without penalty to buy a house if you have not owned a house in the last two years. Each buyer can take out $10,000, so a couple could amass $20,000 toward a home this way if neither partner had owned a home in the last two years. This is a one-time exemption.

Pay medical bills. You can withdraw funds to pay medical bills if your unreimbursed medical expenses exceed 10 percent of your income.

Buy health insurance if you're unemployed. To qualify, you must withdraw the funds during a year in which you received unemployment benefits for at least 12 weeks.

Pay for education. You can withdraw from an IRA to pay qualified education expenses (tuition, fees and related expenses) for yourself, your spouse, your child or your grandchild.

Take the distribution in equal payments. The calculation of what are called Substantially Equal Periodic Payments is complex, and you must take the payments for five years or until you turn 59 1/2, whichever comes later.

Late-career job loss. If you're between 55 and 59 1/2 and you lose your job, you can withdraw funds from your 401(k) without penalty. This exception does not apply to IRAs.

Disability. If you become totally and permanently disabled, you can withdraw from your IRA without penalty.

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