You’ll typically incur a 10% tax penalty when withdrawing funds from an IRA prior to age 59 1/2, but there are certain situations in which this penalty can be avoided.
These exceptions include purchasing your first home, unreimbursed medical expenses that exceed 7.5% of adjusted gross income and unemployment compensation premiums for 12 weeks.
Taxes on IRA withdrawals
As you near retirement age, taxes applicable to your IRA withdrawals will begin increasing as the pre-tax contributions you made become part of your taxable income and account earnings.
However, there are various strategies you can employ to lower the tax liability associated with withdrawals. If you need assistance, speak with a financial advisor using SmartAsset’s free advisor matching tool – they may have one in your area who could assist with that search!
An exception to the 10% penalty may exist if you take substantially equal periodic payments (SEPPs), calculated according to a formula and made on an ongoing schedule until age 59 1/2 is reached. While this strategy may seem straightforward at first glance, mistakes can prove costly in practice; furthermore this exception also applies to inherited IRAs.
Penalties for early withdrawals
For most traditional, rollover, SEP-IRA or SIMPLE IRA accounts, withdrawals at age 59 1/2 or above can only be made when certain conditions exist. But there may be exceptions.
As an initial homebuyer, if you take out up to $10,000 penalty-free from an IRA to purchase a house. This rule also applies to spouses.
Your IRA allows you to withdraw money tax-free when needed for qualifying medical expenses that exceed 7.5% of your adjusted gross income, as well as health insurance premium payments if you lose your job and receive unemployment compensation for at least 12 weeks.
Avoid penalties by making regular, substantially equal periodic payments (SEPPs) from your IRA for an agreed upon number of years or until age 59 1/2, subject to specific IRS rules. It might be wise to consult a financial or tax professional when taking this approach.
Exceptions for early withdrawals
When withdrawing money from an IRA before age 59 1/2, typically income taxes and an early withdrawal penalty of 10% apply. There may be exceptions which allow you to avoid these penalties due to specific reasons.
One of the more frequent exceptions allows you to withdraw funds without incurring penalties if they’re used to cover qualifying higher education expenses, including tuition, fees and books at an eligible educational institution for you, your spouse or any dependent children.
Distributions made to satisfy IRS levies are also exempt. Levy debt must pertain to federal tax debt and cannot target specific individuals. Instead, notice will be sent out and, if payments aren’t made within an agreed-upon time frame, assets including an IRA could be levied by the IRS – however this exemption doesn’t apply in cases involving an inherited IRA levy.
Timing your distributions
Early withdrawals typically incur a 10% penalty. To avoid this fee in certain circumstances, strategic timing of withdrawals can help.
First-time homebuyers may withdraw $10,000 tax-free without incurring penalties if the funds are used to buy, build, or rebuild a residence. Distributions from an IRA can also be taken without penalty if used to purchase permanent health insurance or cover expenses associated with a disability.
One way to avoid paying taxes when withdrawing funds from an IRA is donating them directly to charity. This strategy may be suitable if you don’t require all the funds, since their non-taxable status will make their donation tax-free. A financial advisor or CPA may help determine the most efficient method for you to transfer assets; they may have more long-term thinking than you and ensure compliance with applicable rules when doing so.
