IRAs are meant to be kept and invested until retirement; any attempt at withdrawing assets early can incur severe penalties; however, there are exceptions.
Create and follow an investing plan in order to ensure regular savings. Some companies offer automatic contributions and payroll deposits.
Taxes
Traditional IRAs allow savers to defer taxes on investment income until it comes time to withdraw funds, but early withdrawals before age 59 1/2 often incur an early withdrawal penalty tax of 10% unless an exception applies.
Many taxpayers understand they must include any IRA withdrawals as taxable income, yet many don’t know there are specific rules about when and how these distributions should be taxed. Knowing these rules can help make better decisions about taking out early distributions from an IRA before reaching age 59 1/2.
Retirement accounts are designed to fund your lifestyle in later life, which is why the government imposes a steep financial penalty if you tap your savings early. But there may be certain circumstances in which IRA owners can withdraw funds without penalty, such as using up to $10,000 towards purchasing their first home or paying health insurance during periods of unemployment (known as qualified exceptions).
Exceptions
While the government does not encourage savers to access their retirement savings before they are fully prepared, there are certain exceptions. For instance, both Individual Retirement Accounts (IRAs) and 401(k)s offer penalty-free withdrawals when used to cover medical expenses that exceed 7.5% of your adjusted gross income in any year of withdrawal.
Your contributions and market growth can also be used to pay for qualified education expenses for you, your spouse or children enrolled at least half-time at school – including tuition, fees, books and supplies as well as room and board costs.
First-time homebuyers may withdraw up to $10,000 (indexed for inflation) without incurring a 10% penalty and use it towards purchasing their first residence within 120 days. Funds returned into an IRA are nonrefundable until at least 60 days has passed since being used towards purchasing property. Furthermore, beneficiaries of deceased IRA owners don’t face this tax penalty when withdrawing funds to cover unanticipated expenses from an account that was left open during lifetime.
Rollovers
There are two methods available to you when moving funds from an employer plan to an IRA: direct rollover and transfer. Many financial and tax professionals prefer direct rollover as this eliminates errors more quickly.
An indirect rollover involves having your plan administrator send you a check for your distribution, withholding 20% for taxes. Within 60 days, deposit any remaining funds or those withheld plus the 20% tax obligation into an IRA to complete the rollover and avoid an early withdrawal penalty.
IRS Publication 590-B provides guidance for rollover strategies. If you wish to utilize one, seek the advice of a professional to ensure compliance with its rules as well as understand whether this course of action would be in your best interests; tax laws vary according to each situation.
Withdrawals
Assuming you don’t qualify for an exception, withdrawing funds from an IRA before age 59 1/2 incurs an extra 10 percent tax penalty; however, depending on your individual circumstances and type of account there may be ways around it.
Traditional IRA funds may be withdrawn without penalty for eligible expenses such as medical needs, health insurance premiums and college costs. Furthermore, you can withdraw funds for your first home purchase within two years with neither Roth nor traditional IRA penalties applied; this rule applies equally.
Other permitted withdrawals include “qualified acquisition cost expenses,” such as those related to purchasing, building or rebuilding a home; as well as “reasonable and necessary settlement financing and closing costs,” according to the IRS. You can withdraw funds without penalty to cover long-term illnesses or injuries diagnosed by medical practitioners; alternatively you could use them pay unreimbursed medical expenses that exceed 7.5% of adjusted gross income.
