There are few things more frustrating than watching your retirement funds shrivel up with a falling stock market. From October 2007 to March 2009, the Dow Jones industrial average dropped from more than 14,000 to 6,600, halving the value of many IRAs [source: Google Finance].
Some investors refuse to watch their retirement savings disappear, so they cash in their IRAs to make more profitable investments. But in a down market, that's a big gamble.
If you pull money from a traditional IRA before 59 ½, you will pay income tax on the full amount, plus a 10 percent early withdrawal penalty. So if you have $100,000 in an IRA and you are in the 25 percent tax bracket, you will lose $25,000 to taxes and $10,000 more to penalties. You would have to make one heck of a brilliant investment to recoup those losses.
If you pulled money from a Roth IRA, there's more wiggle room. Since you pay income tax on contributions to a Roth IRA, you can withdraw the amount you have invested — before any earnings — tax-free at any time. If you want to tap the earnings, though, you need to wait at least five years from the time you made your first contribution to the Roth IRA. Otherwise, the earnings will be taxed as income. Both earnings and contributions taken before age 59 ½ will incur the 10 percent early withdrawal penalty, unless you meet some of the exceptions we'll discuss later. Unfortunately, a down market is not one of them.