The contributions you make to your individual retirement account (IRA) are intended to supplement your income during your retirement years. However, as much as you'd like to let your IRAs remain untouched until retirement, unforeseen expenses may force you to withdraw some of those assets early. Traditional and Roth IRA distributions can trigger a 10% penalty if you take them too soon, but there are early-withdrawal exceptions that let you skip the fine.
- You can withdraw Roth IRA contributions at any time, for any reason, without paying taxes or penalties.
- If you withdraw Roth IRA earnings before age 59½, a 10% penalty usually applies.
- Withdrawals before age 59½ from a traditional IRA trigger a 10% penalty tax, whether you withdraw contributions or earnings.
- In certain IRS-approved situations, you may take early withdrawals from an IRA with no penalty.
IRA Withdrawals During Retirement
If you're looking for a tax-advantaged way to save for retirement, a traditional IRA may fit the bill. Traditional IRAs provide an upfront tax break. You can deduct your contributions in the year that you make them, as long as you meet income guidelines. However, you'll pay income taxes on withdrawals at your then-current tax rate during retirement.
With a Roth IRA, contributions are made with after-tax dollars. That means you won't get any tax savings when you add money to your account. But withdrawals after age 59½ are 100% tax-free and penalty-free, provided it's been at least five years since you first contributed to a Roth. As an added bonus: You can withdraw your contributions whenever you like, without tax or penalty.
What Are Penalty-Free IRA Withdrawals?
The Internal Revenue Service (IRS) imposes a 10% penalty on early IRA withdrawals to encourage you to keep your retirement savings intact. However, you may be able to avoid the penalty in certain situations. Here are nine instances where you can take an early withdrawal from a traditional or Roth IRA without being penalized.
1. Unreimbursed Medical Expenses
If you don't have health insurance or you have out-of-pocket medical expenses that aren't covered by insurance, you may be able to take penalty-free distributions from your IRA to cover these expenses.
To qualify, you must pay the medical expenses during the same calendar year you make the withdrawal. Also, your unreimbursed medical expenses must exceed 7.5% of your adjusted gross income (AGI).
For example, if your AGI is $100,000 and your unreimbursed medical expenses are $15,000, the most you can distribute penalty-free is $7,500—the difference between $15,000 and 7.5% of your AGI ($7,500).
2. Health Insurance Premiums While Unemployed
If you're unemployed, you may take penalty-free distributions from your IRA to pay for health insurance premiums. In order for the distribution to be eligible for the penalty-free treatment, you must meet these certain conditions:
- You lost your job
- You received unemployment compensation for 12 consecutive weeks
- You took the distributions during either the year you received the unemployment compensation or the next year
- You received the distributions no later than 60 days after going back to work
3. A Permanent Disability
If you become permanently disabled and can no longer work, the IRS lets you withdraw money from your IRA without paying the 10% penalty. You can use the distribution for any purpose. Just be aware that your plan administrator may require you to provide proof of the disability before signing off on a penalty-free withdrawal.
4. Higher-Education Expenses
A college degree is pricey these days. If you're footing the bill for education expenses, your IRA may be a valuable source of funding. It's possible to avoid the 10% penalty when you use IRA assets to pay for qualified education expenses for you, your spouse, or your child.
Qualified education expenses include tuition, fees, books, supplies, and equipment required for enrollment. Room and board are also covered for students who are enrolled at least half-time. Moreover, the IRS has specific rules about tax benefits and calculating how much is not subject to the 10% penalty.
Be sure to consult with a trusted tax professional to determine whether your expenses qualify. Also, check with the school to make sure it satisfies the requirements to be part of the program.
5. You Inherit an IRA
If you're the beneficiary of an IRA, your withdrawals aren't subject to the 10% early withdrawal penalty.
The exception doesn't apply if you're the spouse of the original account holder, you're the sole beneficiary, and you elect a spousal transfer (where you roll over the funds into your own non-inherited IRA). In this case, the IRA is treated as if it were yours, to begin with. That means the 10% early withdrawal penalties still apply.
Your IRA provider should report the amount you withdraw as a death distribution by including code "4" in box seven of the IRS Form 1099-R, the form that's used to report the distribution. Check with your IRA custodian/trustee regarding the documentation you'll need to process your transaction.
6. To Buy, Build, or Rebuild a Home
You can withdraw up to $10,000 (that's a lifetime limit) from your IRA without penalty to buy, build, or rebuild a home. To qualify, you must be a "first-time" homebuyer, meaning you haven't owned a home in the previous two years. However, you could have been a homeowner in the past and still qualify as a first-time homebuyer today.
If you're married, your spouse can kick in an extra $10,000 from his or her IRA. Also, you can use the money to help out a child, grandchild, parent, or other family members, provided they meet the first-time homebuyer definition.
7. Substantially Equal Periodic Payments
If you need to make regular withdrawals from your IRA for a few years, the IRS allows you to do so penalty-free if you meet certain requirements.
Basically, you withdraw the same amount—determined under one of three IRS pre-approved methods—each year for five years or until you turn 59½, whichever comes later. This is referred to as taking substantially equal periodic payments (SEPPs) from your IRA.
8. To Fulfill an IRS Levy
If you have unpaid federal taxes, the IRS can draw on your IRA to pay the bill. The 10% penalty won't apply if the IRS levies the money directly. However, you can't withdraw the money to pay the taxes in order to avoid the levy. In this case, the exception wouldn't apply, and you'd be on the hook for the 10% penalty.
9. Called to Active Duty
Qualified reservist distributions are not subject to the 10% penalty. In general, these distributions are made to a military reservist or National Guard member who is called to active duty for at least 180 days after Sept. 11, 2001.
In some cases, you may be able to repay the distributions, even if the repayment contributions exceed annual contribution limits. However, you must do so within two years of the end of active duty.
The Bottom Line
Even though the cases cited above are exempt from the early-distribution penalty, they still may be subject to federal and state tax. A trusted tax professional can determine what taxes you might owe and help you to fill out the appropriate forms.
You may find there are other options to get access to funds, such as taking out a personal loan.
Finally, to claim the early-distribution penalty exception, you may be required to file IRS Form 5329 along with your income tax return, unless your IRA custodian reports the amount as being exempt on IRS Form 1099-R.