IRAs are intended to be long-term retirement savings accounts. But premature withdrawals can be costly and incur custodian fees.
IRS rules allow penalty-free withdrawals for certain reasons, including first-time homebuyers; unreimbursed medical expenses; unemployment compensation payments and qualified disaster recovery withdrawals.
First-time homebuyer exception
When withdrawing money from an IRA before age 59 1/2, it’s usually subject to tax and subject to a 10% penalty tax unless one of the IRS exceptions apply. One such exception allows up to $10,000 of withdrawal without penalty as long as it’s used towards buying, building or reconstructing a house within 120 days of withdrawal; unfortunately this only applies to IRAs rather than 401(k).
Your IRA also allows for penalty-free withdrawals if your unreimbursed medical expenses exceed 7.5% of adjusted gross income or you are unemployed and receiving unemployment compensation, or set up substantially equal periodic payments (SEPPs) based on either your life expectancy or joint life expectancies of yourself and beneficiary; however, these withdrawals must still pay taxes at withdrawal time.
Unreimbursed medical expenses exception
Tapping into retirement savings early can come with severe penalties; however, in certain situations an individual can withdraw funds without incurring the 10% early withdrawal fee penalty. Such cases could include purchasing their first home, incurring medical costs, or having their account levied by the IRS.
Individuals are eligible to make penalty-free withdrawals of up to $10,000 from their Individual Retirement Account (IRA). This money may be used towards purchasing, building or reconstructing their first home and any associated settlement costs, financing fees or closing fees.
Unreimbursed medical or dental expenses that exceed 7.5% of an individual’s adjusted gross income are eligible for tax-free distributions; however, payment must occur in the year they were incurred to avoid penalties. Permanent disability as defined by the IRS also qualifies; defined as any physical or mental condition which renders one permanently incapable of pursuing substantial gainful activity and rendering one incapable of any further gainful activity is included within this category.
Unemployment compensation exception
While withdrawing money from your retirement account to cover unexpected expenses may seem appealing, this choice should be carefully considered as it could negatively impact future financial security by taking savings away from compounding growth processes.
There are certain circumstances under which it is permissible to withdraw funds from your IRA without incurring penalties, most commonly related to medical expenses and home purchases. One such instance allows withdrawal without penalty in cases of unreimbursed medical expenses exceeding 7.5% of adjusted gross income (AGI).
An additional exception allows you to use a distribution from your IRA for the purchase or construction of a first home, up to an annual lifetime limit of $10,000, such as fees, expenses, settlement or closing costs. Finally, another provision permits withdrawals from an IRA to buy, build, or rebuild one for you and/or family members living with you.
Disaster recovery exception
Disaster victims impacted by federally declared major disasters can withdraw funds from their IRA without penalty, this includes both traditional 401(k), money purchase pension, 403(b), and government 457(b) plans as well as individual retirement accounts (IRAs).
Unused withdrawals may be used for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income, health insurance premiums if unemployed and qualified higher education expenses. Furthermore, first-time homebuyers can withdraw up to $10,000 penalty-free when purchasing their primary residence and new parents can use their IRA funds without incurring an early withdrawal penalty for birth or adoption costs.
IRS rules allow individuals to withdraw penalty-free funds from an IRA when suffering a permanent and total disability that will lead to their death or indefinite confinement, such as blindness or chronic illness. This exception also covers individuals receiving payments from Social Security Administration as well as terminal diseases.
