In this chapter:
Introduction
Retirement savings plans
The 401(k) plan
IRAs
Roth IRAs
The IRA decision
How your savings grow
Some (minor) drawbacks
Dividing your savings
Inflation & taxation
A newfangled pension
Questions & answers
Security and your 401(k)
The scoop on IRAs
Your savings priorities
If you're self-employed
Financial cramming
 

Some Drawbacks (and Why They Don't Matter)

On the surface, IRAs and 401(k)s have a major downside for young people. Once you put money into these accounts, you may have to wait until you reach the age of 59 to be able to withdraw your money without paying a penalty. If you try to take it out before then, you’ll often get hit with a stiff 10% penalty, plus income tax on the amount you withdraw. 

These tough rules are meant to prevent savers from raiding their retirement plans, since withdrawals generally can’t be replaced. But the rules aren’t actually as rigid as they seem. Here are the details.

Withdrawals from 401(k)s

401(k)s are tough to crack. To withdraw money from them, you must prove to your employer that you need it for something important, such as paying medical bills, and that you have nowhere else to turn. But many 401(k)s do offer an escape hatch: They allow you to 
borrow the money at rates that are sometimes more favorable than a bank’s. When you borrow from your 401(k) you are essentially borrowing money from yourself, and the payments you make—including interest—go right back into your own account. 

Borrowing rules vary from company to company, so check the details with your employer. In general, you can borrow half the amount you contributed to your 401(k) plus earnings. Depending on how long you’ve worked for the company, you may be able to borrow up to half of your employer’s contributions, too. Some employers do not permit loans of less than $1,000. Loans usually must be paid back within five years, although if you use the money to buy your primary home, you may be able to pay it back over a longer period. 

Even if you can’t withdraw or borrow from your retirement plan very easily, it usually still makes sense to invest in a 401(k). The advantage of tax-favored compounding is so great that after about 10 years its benefit could outweigh the 10% penalty you’ll have to pay for making unqualified early withdrawals.

Withdrawals from IRAs

Not surprisingly, the rules for IRA withdrawals differ depending on what kind of IRA you have. Under most circumstances, you will have to pay both income tax and a 10% penalty on IRA money you withdraw before the age of 59. But there are a few exceptions, which can get pretty complicated. Bear with me. 

Roth IRAs have the most lenient guidelines: You can withdraw the money you’ve contributed to them at any time without paying the income tax or the 10% penalty. But that applies only to your contributions; you will have to pay both the penalty and the tax if you withdraw the earnings on your contributions before you retire.

The government also lets you withdraw money from any IRA, without paying the 10% penalty, for any of the following reasons:

educational expenses for yourself, your spouse, or your children (including tuition, fees, books, and possibly room and board); 

unreimbursed medical expenses if they exceed 7.5% of your adjusted gross income;

up to $10,000 in homebuyer costs. This loophole is an especially big deal for Roth IRAs, because it generally lets you avoid paying the income tax on your withdrawal as well as the penalty. (I say "generally" because if your Roth IRA is less than five years old, you will not be spared the tax.) The $10,000 limit is a lifetime cap per person, and the exemption is reserved for people who have not owned a house in at least two years. 

One last tip: If you need your IRA money for a short period of time, you can borrow it once a year, without tax or penalty, as long as you pay it all back within 60 days.