Did you know the IRS has provisions to their 10 percent early-withdrawal rule for IRAs? Yes, it’s true! You don’t have to pay that penalty if you withdraw funds for specific reasons before you turn 59 ½ years old.
Of course, it’s typically best to wait to withdraw funds from your retirement plan until you reach retirement age. You are trying to save money, after all. Early withdrawals defeat that purpose and deplete the income you’ll have to finance your comfortable retirement. On top of that, you face paying income tax on that distribution, plus a 10 percent early-distribution penalty. Not a pleasant thought.
However, there are some instances the IRS deems it fit for you to withdraw some money without worrying about that pesky penalty.
Penalty-Free Early Distributions from Your IRA include:
Pay for medical costs: If you’re under the age of 65 and have non-reimbursed medical costs that total more than 10 percent of your adjusted gross income (AGI), you can withdraw funds from your IRA to pay them without penalty.
Finance a first-time home purchase: Penalty-free withdrawals can be taken up to $10,000 (or $20,000 for couples) to pay for a house or for the construction of a new home. To qualify for the exemption, you cannot have owned a home for at least two years before the purchase/construction of the new home.
If you are disabled: You must have severe physical and/or mental disabilities that prevent you from working (as well as a doctor’s verification of that condition) to take penalty-free distributions from your IRA.
Purchase health insurance: If you are unemployed and receive unemployment compensation for 12 consecutive weeks—you can take money from your IRA to pay for health insurance for you and/or your dependents. The rule to avoid penalty here is the distribution has to be taken either in the same year you collected unemployment compensation or the next year, but before you become employed for 60 days or longer.
Cover college expenses: You can take penalty-free distributions to pay for tuition, the cost of books, supplies, and other qualified expenses. Also, if the student is considered at least a part-time student you can pay room and board with those funds, as well. One thing to be aware of is that these distributions are considered taxable income—and may negatively impact your eligibility to receive financial aid.
Not all retirement plans offer this exemption, but some offer other exceptions
For example, if you have a qualified plan such as a 401(k), you are eligible for penalty-free distributions if you have a disability or pay for medical costs as outlined above. But, distributions for college, health insurance, or for a new home are not exempt early distributions from these plans.
But wait, there are more!
Yes, there are a few more exemptions than the ones we outlined above. Find the full list of qualifying early-withdrawal exemptions from the 10 percent penalty in IRAs and 401(k)s, in Retirement Topics - Exceptions to Tax on Early Distributions published by the IRS. Included is a handy chart outlining what exemptions apply to each plan.
Taking early distributions from your retirement plan requires much thought and planning on your part. You want to ensure any withdrawal you make is necessary and worth depleting your hard-earned savings—and you want the withdrawals to be compliant within IRS standards, as well.
This article was written for basic informational purposes only. We recommend you consult with your financial advisor before taking an early withdrawal from any retirement plan to ensure it qualifies for the exemption of the penalty.