Advantages & Disadvantages of Liquidating IRAs
Original post by Chris Blank of Demand Media
You may be considering liquidating some or all of the money you have invested in one or more individual retirement accounts. Before liquidating your IRAs, carefully consider the advantages and disadvantages. While there are situations that justify liquidating your IRA, in other instances, the disadvantages far outweigh the advantages. Consult with a financial professional who specializes in retirement investment funds with specific questions.
Source of Emergency Funds
Although many financial advisers recommend having a reserve fund sufficient to cover six months worth of expenses, many people find it difficult or impossible to set aside that much money. Other people might have had an emergency fund at one time, but have drained it already. In a financial emergency, such as a catastrophic illness or long-term unemployment, sources such as life insurance policies and IRAs may represent the only source of cash available other than credit card cash advances, short-term loans and other high-interest sources of cash.
First Home Deduction
If you are buying, building or rebuilding your first home and you are withdrawing no more than $10,000 from your traditional IRA, you may do so without additional tax penalties, no matter what your age, although you must still pay regular income tax on the money. If you are married, you and your spouse are each entitled to make a $10,000 withdrawal from your individual IRAs without additional tax penalty. Given this fact, and considering the tax deductions allowed for home ownership, you may be able to offset much of the tax burden you incur from liquidating your traditional IRA, according to Bankrate. You may also withdraw up to $10,000 from a Roth IRA. Because the funds you contribute to a Roth IRA are drawn from post-tax wages, you incur no tax penalty or obligation at all, according to "Kiplinger."
Tax Penalties for Early Withdrawals
If you are under age 59 1/2 when you make a withdrawal from a traditional IRA that is not covered by one of the early withdrawal exemptions, you may be subject to an early withdrawal penalty of 10 percent in addition to the regular tax liability you would incur. Although you may freely withdraw from your contributions to a Roth IRA without taxation or penalty, if you withdraw earnings -- that is, interest generated by your contributions, before you reach age 59 1/2 -- you are liable for a 10 percent early withdrawal penalty, "Kiplinger" states.
Loss of Bankruptcy Shield
Many people consider liquidating their IRAs to save their homes from foreclosure or to pay off high-interest credit card debt. However, if creditors are threatening to garnishee your wages or seize your assets, liquidating your IRA is an especially bad idea. This is because funds held in an IRA are generally exempt from inclusion as part of your estate during the bankruptcy process. If you liquidate those funds, they lose that protection. Worse, in many cases you wind up filing for bankruptcy anyway, according to the National Bankruptcy Forum.
- Internal Revenue Service: Publication 590 --Traditional IRAs
- Internal Revenue Service: SIMPLE IRA Plan; November 2010
- Internal Revenue Service: Simplified Employee Pension Plan (SEP); November 2010
- "Smart Money"; How to Deduct IRA Losses; Bill Bischoff; December 2008
- Bankrate; IRA Homebuyer Rules; George Saenz; June 2008
- "Smart Money"; What Are Your IRA Options?; January 2011
- National Bankruptcy Forum; Exemptions, 401k Plans, Iras and Common Liquidating Mistakes By Well Meaning Debtors John C. Colwell; May 2011
- "Kiplinger"; Why You Need a Roth IRA; Erin Burt; March 2009
- Internal Revenue Service; 2010 IRA Contribution and Deduction Limits; November 2010
- Internal Revenue Service; Retirement Plans FAQs Regarding IRAs; July 2011
About the Author
Chris Blank is an independent writer and research consultant with more than 20 years' experience. Blank specializes in social policy analysis, current events, popular culture and travel. His work has appeared both online and in print publications. He holds a Master of Arts in sociology and a Juris Doctor.
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