Most individuals withdrawing funds from an IRA before reaching age 59 1/2 must pay income tax plus a 10 percent penalty; however, there may be exceptions to this rule.
As an early homebuyer, for instance, you may qualify to withdraw up to $10,000 without incurring penalties, provided they’re used towards buying, building or rebuilding a new house – while medical expenses may also qualify.
Hardship Withdrawals
Savers who take early withdrawals from retirement accounts prior to age 59 1/2 typically face a 10% penalty and regular income taxes upon withdrawing funds, however there are exceptions available from the IRS which allow those using an IRA or workplace plan account to take money early without incurring this additional tax penalty.
Assuming you qualify, first-time home buyers who need assistance withdrawing funds can do so penalty free, provided they fall within IRS guidelines for hardship distributions. Please check with your employer as to which expenses qualify as hardship distributions as well.
Self-employed individuals can access their IRAs early without incurring penalties by setting up what the IRS refers to as Substantially Equal Periodic Payments (SEPP) plans, which offer penalty-free distributions over five years or until age 59 1/2, whichever comes first. As with a traditional hardship withdrawal, SEPP distributions will still count as annual income for tax purposes.
Annuity Payments
There are certain circumstances under which IRA owners can withdraw funds without incurring a 10% early withdrawal penalty, however those who withdraw early risk eroding their savings and paying both regular income taxes as well as the 10% early withdrawal fee.
The IRS levies an early distribution penalty on traditional and Roth IRAs to discourage savers from tapping into their retirement accounts too soon, according to Blaine Thiederman of Progress Wealth Management. However, under certain conditions you may be exempt from paying this charge, according to Thiederman.
An IRA allows you to withdraw funds penalty-free if the funds are used for one of the following: A first home purchase by you, your spouse, children or grandchildren; medical expenses exceeding 7.5% of adjusted gross income; purchasing a new car or helping a child start college; etc.
Charitable Donations
If you want to avoid paying taxes on an early IRA withdrawal, consider giving to charity instead. Giving can reduce your adjusted gross income and possibly prevent higher Medicare Part B and Part D premiums while being tax deductible according to Kraus.
Schwab Charitable accepts gifts of appreciated publicly traded securities that have appreciated in value and can help donors reduce or avoid long-term capital gains tax (if held over one year). Furthermore, donors who transfer ownership of privately held businesses directly to Schwab Charitable may even completely avoid capital gains tax altogether.
Keep a record of all charitable donations you make for tax purposes. In order to claim a deduction, qualifying documents such as bank statements, credit card statements, cancelled checks and receipts from organizations should be collected as supporting evidence. Schwab recommends using its tax-deductible contribution calculator in order to better assess how their contributions might impact their tax situation.
Qualified Distributions
Withdrawals made prior to age 59 1/2 generally incur taxes and a 10 percent penalty. There may, however, be exceptions and tax-efficient strategies exist for early withdrawals from traditional IRAs and employer-sponsored retirement accounts.
One exception allows first-time homebuyers to claim distributions without penalty for costs incurred when buying, building or rebuilding a house as well as “any usual or reasonable settlement costs,” per the IRS.
Retirees can use their IRA funds to pay unreimbursed medical expenses that exceed 7.5% of their adjusted gross income, although the IRS only allows this withdrawal in the year it occurred, according to Pederson. When withdrawing funds it’s crucially important that timing your withdrawals is done so.
People serving in the military who have been called up are exempt from paying the penalties associated with IRA withdrawals, provided they complete at least 180 days or indefinite service and make their first qualified distribution within 120 days after leaving military service. To qualify, this provision requires active duty for at least 180 days or for indefinite service prior to making their withdrawal from an IRA.
