How can I draw retirement income early from my IRA or 401(k)?

Dear Dollar Diva,
My company is entering a merger, and I will be taking an early retirement package that will give me about 56 percent of my current income. I will be 56 years old when the merger is finalized. If I find myself short of cash and need to tap my IRA or 401(k), what is the penalty and how can I minimize it? Are there institutions that will make short-term loans against the value of my IRA or 401(k)?

Congratulations on your early retirement. Life can be a bowl of cherries when you buy your soul back from the company store; but it can be the pits if you can't afford to maintain your lifestyle. Don't rule out working on something that would be fun. Combine the tight labor market with your retirement income, and the Diva sees you sitting in the driver's seat. Read "Working after retirement" and AARP's "Working options: a guide for mid-life and older workers" for some ideas.

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Tapping into your IRA

Here's the bad news: When you withdraw money from an IRA before you're 59-1/2 you almost always have to pay an additional 10 percent tax on the early withdrawal.

Here's the good news: You are a perfect candidate for an exception that exists within the IRA rules: the annuity payout. You can be any age to use this method, but it's tailor-made for someone in your position. The Diva will give you a summary of the rules. For the nitty gritty go to the IRS Publication 590, Individual Retirement Arrangements (IRAs).

You can receive distributions from your IRA if you take them as a series of equal payments over your life expectancy.
The payment schedule has to be one the IRS approves.
You must take at least one distribution annually.
The payments must continue for at least five years or until you reach age 59-1/2, whichever is the longer period (in your case five years, until you are 61 years old).
After the five years, you can do whatever you what: increase, decrease, or stop the payments.
The payment plan you set up is written in stone -- in your case for five years. If you change it -- perhaps by taking an additional lump sum -- say hello to a 10 percent penalty for not only the lump sum but all prior distributions as well.

Tapping into your 401(k)

Normally, you'd expect to pay a 10 percent penalty on 401(k) distributions, but you've lucked out with another exception. If you take money from your 401(k) plan after your separation from service, the magic age is 55 for not having to pay the extra 10 percent.

IRS Publication 575, Pension and Annuity Income will give you the scoop on this one.

IRA or 401(k) as collateral for loan

Don't even think about it. Using an IRA or 401(k) for collateral is called a "prohibited transaction," and it's goodbye collateral, hello taxable distribution.