Individual retirement accounts (IRAs) are designed to grow over the long-term, but unexpected expenses or emergencies may necessitate early withdrawals from them. Early withdrawals typically incur a 10% penalty but there may be exceptions.
Public safety employees put their lives on the line every day to serve and protect their communities, so Congress recognizes their sacrifice by exempting them from paying an early withdrawal penalty of 10%.
Emergency Personal Expense Distributions
Tax-favored retirement plans now provide an exception from the 10% penalty when distributions are used to cover emergency personal expenses or domestic abuse victims. Employers may add this provision through discretionary plan amendments for plan years commencing post December 31, 2023.
To qualify, distributions must meet unforeseeable or immediate financial needs for necessary personal or family emergency expenses (for instance a natural disaster, medical expense, loss of employment, needing child care payments and automobile repairs) that cannot wait up to 90 days (the limit on such distributions being $1,000). The plan administrator may rely on written self-certification from participants that these expenses exist as proof.
Establishing substantially equal periodic payments (SEPPs) is another exception to the 10% penalty, providing regular distributions from your IRA over your life expectancy. Unfortunately, this option could result in taxable income if terminated before age 59 1/2 or 5 years have been reached.
Domestic Abuse Victim Distributions
The SECURE Act of 2022 included provisions for two additional optional distributions to address emergency needs: emergency personal expense distributions (EPEDs) and domestic abuse victim distributions (DAVDs). Like EPEDs, these distributions do not incur an early withdrawal penalty of 10%; however, unlike EPEDs they must allow participants to repay all or part of them within any three year period.
The Domestic Abuse Victim Disbursement (DAVD) provision, available under qualified retirement plans that offer this feature, allows participants who self-certify as victims of domestic violence to take distributions equal to either $10,000 indexed for inflation or 50 percent of their vested account balance. Domestic violence includes physical, psychological, sexual, emotional and economic abuse against either an individual, their children, spouse or domestic partner as well as any efforts at control or intimidation of such persons or bodies.
IRS Notice 2024-55 recently provided sponsors with clarity regarding these new distribution provisions, detailing how they will operate. It’s essential that they review these rules, establish appropriate administrative processes and participant communications protocols, as well as promote their availability to participants.
Qualified Higher Education Expenses
Use of your IRA to cover higher education expenses is one exception to the 10% penalty rule, qualifying as expenses such as tuition fees, books, supplies and equipment costs, room and board costs as well as room rental expenses. Institution must be accredited postsecondary school participating in federal student aid programs for expense to qualify; extracurricular activities like drama club fees do not qualify. You should receive a Form 1098-T from school detailing which expenses qualify.
Education expenses must be for either yourself, your spouse, children and/or grandchildren of both you and your spouse, or paid using a 529 plan. When using this approach to pay for these costs, account owners or beneficiaries must keep enough records and receipts to demonstrate they meet IRS regulations – this process can be complex so always consult with a tax expert first before drawing money out of an IRA account.
Excess Contributions
Any withdrawals from retirement accounts (traditional IRAs, 403(b) annuity plans and SIMPLE IRAs) prior to age 59 1/2 will usually incur income taxes and a 10% penalty; with certain exceptions (e.g. using funds for qualified higher education expenses for you, your spouse or your children or medical expenses exceeding 7.5% of your adjusted gross income).
Numerous exceptions allow you to withdraw your IRA funds without penalty in certain situations, such as buying your first home or meeting temporary disability expenses. Unemployed individuals using their IRA funds to pay medical insurance premiums also qualify. Starting in 2024, SECURE Act 2.0 introduced two additional exceptions allowing penalty-free early withdrawals for emergency personal expenses and domestic abuse victim distributions – but due to complex rules we advise consulting us first if planning such withdrawals.
