Withdrawals from an Individual Retirement Account (IRA) before age 59 1/2 generally attract ordinary income tax and a 10% penalty; however, there may be exceptions.
Before making a withdrawal from an IRA account, it is wise to consult the IRS or an expert for their personal tax and financial situation. This article will also detail some key IRA withdrawal exceptions:
1. Qualified Medical Expenses
Individual Retirement Accounts (IRAs) are tax-advantaged savings plans designed to allow individuals to invest pre-tax funds for retirement. There are various kinds of IRAs, such as traditional IRAs, Roth IRAs and SEP IRAs (an employer-sponsored retirement account available only to small business owners and self-employed workers).
Substantial medical expenses may require you to withdraw funds from your IRA without incurring an early withdrawal penalty, providing they exceed 7.5% of your adjusted gross income. Withdrawals could also help cover uninsured medical bills that exceed that threshold.
Penalty-free withdrawals from an IRA may also be used to pay for college tuition, fees, room and board for yourself or family members who attend eligible educational institutions. Furthermore, funds from an IRA may help finance the purchase of your first home.
2. College Expenses
Traditional and Roth IRAs do not typically impose a 10% penalty when withdrawing earnings to cover college expenses for either themselves, their spouses or children. This exception covers tuition costs for higher education for everyone within an account – whether this means tuition for the owner themselves, spouse or offspring of either party.
However, those looking to use their IRA as a financial aid resource should keep in mind that any withdrawals count as income on their FAFSA application and may reduce need-based awards. Any funds taken out must be used within 60 days for eligible expenses and must provide receipts as evidence.
Withdrawals from an IRA may also be permitted without incurring penalties for unreimbursed medical expenses that exceed 7.5% of adjusted gross income and first-time home purchases (up to $10,000 per person for couples) that meet IRS guidelines for permitted distributions from your IRA. Check here for the IRS list of permitted distributions of an IRA.
3. First-Time Home Purchases
IRS rules permit withdrawals from traditional IRAs without penalties in certain situations, including medical expenses exceeding 7.5% of adjusted gross income, funeral costs and home purchase or repair. First time homebuyers may withdraw up to $10,000 tax-free from their IRA to help purchase, build or repair their primary residence within 120 days and avoid taxed income.
Penalty-free IRA distributions may also be used to cover educational costs, including tuition, fees, books and supplies as well as room and board at an eligible institution. However, the first-time homebuyer rule does not apply to children, grandchildren or parents of an IRA owner who do not meet its definition as first-time buyers.
4. Disabled Individuals
Many individuals who work for small businesses save for retirement through employer-sponsored retirement accounts such as SEP IRAs and SIMPLE IRAs, while self-employed people may establish individual IRAs which offer more flexible contribution limits than a traditional IRA.
IRA withdrawals made before age 59 1/2 typically incur a 10% early withdrawal penalty, barring certain exceptions. Withdrawals made to SEP or SIMPLE IRAs due to disability can be made without incurring such fees, provided you can provide documentation from your doctor showing why working is impossible or likely won’t resume for some time.
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5. Members of the Military
Individual Retirement Accounts offer tax-deferred savings until withdrawal in retirement, when withdrawals are taxed as ordinary income unless certain penalty-free withdrawals occur.
Individuals employed at small businesses or working for themselves can take advantage of payroll deductions to save with traditional or Roth IRAs or SEP IRAs (Simplified Employee Pension plans), while receiving unemployment compensation can access them without penalty.
Individual Retirement Account (IRA) owners can take one penalty-free withdrawal of $10,000 when purchasing their first home, provided that it has been owned for less than two years. Furthermore, individuals can use their funds from an IRA account without incurring penalties for tuition expenses such as tuition, room and board, books and supplies (but the account holder must first have been an actual student before making this withdrawal).
