What if, for some reason, you really do need to make a withdrawal from your IRA before you are 59.5 years old? One example is withdrawing a Roth IRA contribution without penalty, which you can do at any time. Some folks were wondering how hard it would be to do so, so I just tried to withdraw $100 from my Roth IRA held at Vanguard. Would they put up a fight? Require forms signed by a notary public? Ask for a DNA sample?

It turns out, they simply subject you to a long series of confirmation screens. You can follow along yourself if you have an account too – just be sure not to click on that final “Submit” or you’ll actually do it!

First, I logged into Vanguard.com, went to my IRA account, and clicked on “Buy & Sell” to try and sell some one of my mutual fund holdings (VEIEX for the curious). They immediately throw up a warning:

Bravely, I clicked “Yes”. On the next page, I could choose the amount to sell and how I’d like the proceeds sent to me:

• Electronic bank transfer—Two business days if submitted before 4 p.m., Eastern time; three business days if submitted after 4 p.m.
• Wire— The redemption proceeds will leave Vanguard by the close of business on the next business day; two days if processed after 4 p.m. Eastern time.
• Check—Within 7 to 10 business days.

For some reason, the Wire option wasn’t available in the pulldown menu. Instead, I was given the option to exchange the money into a fund within my taxable account held at Vanguard. I went ahead and chose to send it directly to my linked bank account. This led me to the tax withholding page:

Tax withholding information
Moving money out of a retirement account is a distribution. Qualified Roth IRA distributions are not subject to federal income tax. All or a portion of nonqualified Roth IRA distributions may be subject to federal income tax.

You can either elect to have no federal income taxes withheld from your Vanguard Roth IRA distribution or request withholding at a rate between 10% and 100%. You will remain liable for payment of federal income tax on the taxable portion, if any, of your withdrawal. Tax penalties may also apply if your estimated income tax payments or income tax withholdings are insufficient under federal or state rules.

Since I am pretending to only withdraw a contribution, I chose not to withhold anything. Again, a warning screen appears:

Do you want to continue?
The transaction you have selected involves a premature distribution that is not due to death of the original IRA owner. This distribution will be coded and reported to the IRS as J—Early distribution from a Roth IRA.

Next up is a screen about whether you’d like a tax withholding notice sent to you via e-mail or snail mail.

Receive a tax withholding notice
Because you are completing a distribution from a retirement account, you may request a copy of the tax withholding notice. This notice is for informational purposes only.

Since my fund has a redemption fee, the next page reminds me that this fee will be taken out of the proceeds of the sale:

The Emerging Markets Stock Index Fund imposes a 0.25% redemption fee on the total amount of this redemption.

I acknowledge all this, which finally leads me at the last confirmation page.

Review & submit
Your Vanguard® fund redemption will be processed using the closing share price on the business day on which Vanguard receives your request. Requests received after the close of the New York Stock Exchange (usually 4 p.m., Eastern time) will be processed using the next business day’s closing price.

That’s it! I quickly click on Cancel, and no action was taken.

Summary

In less than 2 minutes, I was able to request an early withdrawal online from my Vanguard IRA. No humans, no forms to send in. Good to know. Taking 2-3 business days directly into my bank account seems fair enough. A wire transfer would be even faster, although there would likely be a fee involved.

It’s getting very close to April 15th, which in addition to tax returns is also the funding deadline for IRAs in the 2009 tax year. A reader wrote in asking whether they should dip into their savings in order to fully fund their Roth IRA contribution for the year. I would imagine this is a common scenario this time of year.

Let’s say that your income is under the phase-out limits and you can contribute the full $5,000. (See this IRS page for more info on limits.) Perhaps you’ve contributed $3,000 so far. You can either take the remaining $2,000 out of your other accounts (emergency fund, car repair fund, sell stocks, etc.) and fully fund the entire $5k, or simply stop where you are.

An important fact to know here is that anyone can withdraw their Roth IRA contributions at any time, without penalty. (This means just your original contributions, not any earnings on those contributions.) However, you cannot retroactively make contributions to past years. In my example above, you couldn’t just contribute $5,000 + $2,000 = $7,000 next year.

Thus, if you feel that you would likely be able to max out in future years, it may be better to simply make your contributions now. It would be quite sad to miss out on a one-time opportunity for tax-free earnings forever! If you do need the money later, you can always withdraw it again. The early withdrawal process is not that complicated, although you will have some additional paperwork to fill out come tax time.

More details about the actual IRS fine print in this post: Can I Really Withdraw My Roth IRA Contributions At Any Time Without Tax Or Penalty?

There are always some possible wrinkles, of course. If it is truly an cash-under-the-bed emergency fund, you should know it make take a few business days to make an IRA withdrawal. In addition, if you really do foresee needing the money, then you may want to invest in conservative options like CDs or money markets. If you are selling stocks, you may be subject to taxes on capital gains. But you buy the same stock in the Roth IRA, you’ll be able to defer taxes on future gains.

Morningstar recently started publishing their Morningstar Lifetime Allocation Indexes, which are designed as benchmarks for mutual funds that shift their asset allocation as a target retirement date nears. An example is the Vanguard Target Retirement 2045 fund (VTIVX), a buy-and-hold fund designed for those retiring around the year 2045.

Created using historical performance data with Ibbotson Associates, the indexes provide asset allocations that are optimized based on Modern Portfolio Theory. The asset classes included are US and international stocks, US and international bonds, inflation hedges like TIPS and commodities, and cash. However, the interesting part is that their “efficient frontier” optimization model incorporates the idea of human capital, which is defined as the present value of a person’s future earnings.

Here is a chart from their factsheet explaining the idea (click to enlarge):

Accordingly, there are 13 indexes with three different risk profiles – aggressive, moderate, and conservative. It is recommended that you choose the proper profile not based on your love of risk-taking, but based on the quality of your human capital:

Human capital is defined as the present value of a person’s future earnings. This ability to work and earn money over time is like a giant bond that provides fairly stable cash flows. The human capital bond is not investment-grade for all investors however. Some investors have stable income streams and thus should have a higher capacity for market risk. Others have income streams that are more sensitive to economic conditions and should therefore have a more conservative financial asset allocation.

Without further ado, you can view all the asset allocations here. I’ll probably make a nice graph out of this later. For now, let’s say I wanted to retire at about age 50 in the year 2030, and I feel my human capital is moderately stable. The Moderate 2030 asset allocation looks something like this:

84% Stocks
— US 57%
— International 27%
10% Bonds
— US 10%
6% Inflation Hedges
— Treasury Inflation-Protected (TIPS) 1%
— Commodities 5%

I don’t really have any further thoughts on it, besides the fact that I don’t think we should necessarily base everything on historical returns. It might be better to try and figure out the source of those returns. Otherwise, it’s just another data point to add to the many model asset allocations out there.