Traditional IRAs allow tax-deferred growth, but withdrawals before age 59 1/2 incur a 10% penalty and should be treated as taxable income.
There are exceptions to the penalty. One such exception allows first-time homebuyers to withdraw up to $10,000 without incurring a fee or penalty.
Total and permanent disability may trigger penalty-free distributions, as can death and certain medical expenses.
First-time homebuyer
Many people use their retirement savings to purchase or build a new home. The IRS allows first-time buyers to withdraw up to $10,000 without incurring an early withdrawal penalty from any IRA, giving individuals enough capital for purchasing, building or renovating their first primary residence. This rule applies to traditional, SEP/SIMPLE and Roth IRAs – although an early withdrawal penalty of 10% exists as a safeguard against draining nest eggs prematurely and increasing dependency upon government assistance for retirees.
Meilahn advises working with an expert before withdrawing funds from an IRA, to understand any tax repercussions. For instance, contributions can be withdrawn penalty-free after age 59 1/2; any earnings withdrawn before then are subject to penalties and taxes; exceptions include paying college tuition and fees or health insurance premiums for the unemployed as well as expenses related to death or disability. IRA owners can choose either lump sum distributions or substantially equal periodic payments (SEPs) over life expectancy.
Disability
Disability may allow you to withdraw money from your IRA without incurring a penalty, typically before age 59 1/2 and for unreimbursed medical expenses exceeding 7.5% of adjusted gross income. Unemployed individuals can access their IRAs without penalty to cover health insurance premiums in the year they withdraw; as long as they also receive unemployment compensation during that year.
To qualify for this exemption, you will need a physician’s diagnosis that indicates your disability is expected to be permanent or long and indefinite in duration. When making your distribution request, present this documentation to your IRA provider; some financial organizations prefer their IRA owners file an additional tax form claiming this benefit; other organizations take the approach that it’s the IRA owner’s responsibility to make sure they qualify; this decision must be based on each organization’s business models and internal policies.
Death
IRS does not penalize IRA beneficiaries who withdraw before age 59 1/2 for withdrawing early, but the earnings portion must still be taxed as income. Beneficiaries can sidestep this penalty if their withdrawals are used for qualified expenses.
These expenses could include medical costs that exceed what your health insurance will cover, unreimbursed expenses exceeding 7.5% of adjusted gross income and first-time home purchases, higher education expenses or military deployment as examples of where withdrawal without penalty could apply.
You may also avoid the penalty if you are unemployed for 12 consecutive weeks or have experienced a natural disaster that affects your home, job or income; however, an IRS Form 5329 must still be filed when making these withdrawals. To learn more about penalties and requirements associated with your IRA account, speak to a financial advisor – SmartAsset’s free tool matches you up with pre-vetted advisors in your area who offer free initial phone consultation calls so you can discuss finances and goals freely with them.
Unpaid taxes
Rothstein suggests contacting your IRA custodian about withdrawing funds penalty-free if the IRS seizes your IRA account for unpaid taxes, suggesting a separate bank account or having it sent directly to an insurance carrier may help avoid audit.
Your IRA withdrawals may also be used to cover unreimbursed medical expenses exceeding 7.5% of your adjusted gross income (AGI), with up to a maximum distribution limit of $7,500 per distribution.
Inherited IRAs are subject to taxes but do not incur the 10% penalty, as the original owner’s base, which represents how much money was contributed, passes to their beneficiaries at death. Beneficiaries can take distributions based on life expectancy or, if self-employed, set up a SEPP plan which will distribute payments annually according to a formula specified by the IRS.
