Creating a retirement fund can be a wise choice. A pension can be a safety net that potentially stabilize their finances after they reach an age where they can no longer work. However, life is unpredictable, and many things can prompt a person to cancel their pension and get the money early.
Following recent reforms, the vast majority of states allow early pension release. What’s more, people over and under the age of 55 can get access to their pension funds ahead of time. While this is good news in case of an emergency, it comes with many downsides.
Therefore, workers wondering if they should cancel their pension and get their money first need to understand all the rules of an early pension release.
Can I Access My Retirement Funds Early?
Traditionally, a pension is something a person gets after they retire. However, it is possible to access these funds while still employed.
Different states allow early access to their pension to those who meet several criteria. For example, in Pennsylvania, people need to be over 55, and have at least 80 Pension Credits to qualify for a ‘Special’ Early Retirement Pension. What’s more, they also need to have completed at least 500 hours of work in the last three years to get the funds.
Is it possible to convert pension to cash? People can either cash out their retirement pot in one go or a series of lump sums. On the one hand, accessing all the available money immediately can be a life-saver. However, it’s important to note that withdrawing large sums can put a person in a higher tax bracket.
When it comes to those who haven’t reached 55 yet, but want to get their pension early, they can do so under certain circumstances. People with a permanent disability can get access to their retirement if they’ve accrued at least 10 Pension Credits. Moreover, they also need to have spent over 3000 hours working in Covered Employment for at least 5 years before becoming permanently disabled.
Is It Smart to Access Pension Funds Early?
As established, it’s possible to access retirement funds early. However, what if a person is under 55 and doesn’t meet the above-outlined criteria? Is it possible for them to access their funds nonetheless?
The answer is yes. Everyone has the legal right to access their retirement money. However, withdrawing said funds is risky for several reasons. First, there’s a real possibility that the money will run out before retirement sets in. Most people underestimate how long their retirement will last. Therefore, they end up taking out too much, too soon. As a result, they don’t have any finances left during one of the most vulnerable periods of their lives.
The second reason early pension release isn’t a good option for those under 55, is the extra fees. Pennsylvania is one of the best places to retire, because of the tax exemptions the state offers pensioners. However, when it comes to early pension releases, the tax exemptions don’t apply. Anyone making early withdrawals from their fund may be subject to PA’s income tax if their total distribution exceeds their total contribution.
For example, if a person has invested $10,000 into their 401(k) and that amount has grown to $30,000, they won’t be taxed on the initial 10k, since it's their money. However, the remaining 20k will be taxed at a rate of 3.07%.
Lastly, there’s a real chance that the person will lose all the other benefits their pension provider gives them. These include life insurance, benefits for any dependents on their pension plan, and matching contributions from their employer.
Can I Recover My Retirement Funds?
While getting an early pension release is risky, a lot of people think that they’ll be able to recover it. Most states will allow someone to open both an IRA and 401(k) accounts. Therefore, if a person leaves their job and cancels their 401(k), they’ll always have their IRA to fall back on. Plus, banks frequently offer perks like investment returns to clients if they decide to keep all their money with one bank.
However, there are problems with this option. When it comes to the IRA accounts, if a person’s MAGI, or modified adjusted gross income, exceeds a certain amount, they may not be able to make tax-advantaged contributions in any given tax year. What’s more, any benefits a person may reap by having savings and a retirement account at the same bank are unlikely to be substantial enough to recoup their losses.
Banks only offer ‘relationship pricing’ to clients if they deposit a certain amount of money in their accounts. Consequently, these benefits aren’t worthwhile for people who can’t make sizable contributions to their IRA.
Final Thoughts
Unexpected financial emergencies make a lot of people wonder if they can cancel their pension and get their money early. While this is possible under a specific set of conditions, it comes with many downsides. Getting an early pension release can leave a person without financial independence in their sunset years.
Therefore, anyone thinking about accessing their pension ahead of time should consider talking to a professional before making a final decision. With years of experience helping clients plan for their financial future, the financial advisors at Kelley Financial Group are always willing to aid clients with any dilemmas regarding their pension funds. They can also help those who are concerned about why financial advisors need tax returns.
Disclosure: Fixed and Variable annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. This information is not intended to be a substitute for specific individualized tax, legal, or investment related advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor. Historical returns are no indication of future returns in any given asset class.
This material was prepared for The Kelley Financial Group.