Some distributions from traditional IRAs are optional while others are mandatory. The income tax and penalty that apply to distributions from a traditional IRA depend on the IRA owner's age at the time of the distribution and the tax-deductibility treatment of the assets at the time of contribution.
Most taxpayers intend to retain assets in their IRA until their retirement years, but, for varying reasons, people are sometimes forced to distribute assets earlier than planned. Distributions that occur before the IRA owner reaches the age of 59½ are subject to a 10% early-distribution penalty, in addition to any income tax owed.
The IRS will waive this early-distribution penalty when distributions are used for certain reasons. These include the following:
Unreimbursed Medical Expenses
If the distribution is used to pay unreimbursed medical expenses, the amount that exceeds 10% of the individual's adjusted gross income (AGI) for the year of the distribution will not be subjected to the early-distribution penalty. In other words, the amount paid for the unreimbursed medical expenses minus 10% of the individual's adjusted gross income for the year of the distribution can be distributed penalty free.
For Medical Insurance Payments
Individuals can make a penalty-free distribution to pay medical insurance for themselves, their spouses and their dependents provided the distribution occurs under the following four conditions:
For a Disability
If an individual becomes disabled before age 59½ and makes a distribution from his or her traditional IRA because of the disability, the distributions are not subject to the early-distribution penalty. Individuals are considered disabled if they furnish proof that a physical or mental condition inhibits them from engaging in substantial gainful activities. A physician must determine that this condition can be expected to result in death or to continue for an indefinite duration.
As Distributions from an Inherited/Beneficiary IRA
Distributions from an Inherited IRA are not subject to penalty, even if the distributions occur before the beneficiary reaches age 59½.
As Part of a SEPP Program
Here are the rules for penalty-free distributions that are part of a series of substantially equal periodic payments (SEPP) over the life of the IRA owner, or the life of the IRA owner and his or her beneficiary: The payments must last five years or until the IRA owner reaches age 59½ – whichever is longer – and the payments must also follow certain IRS-approved methods and meet specific requirements.
For Qualified Higher Education Expenses
Amounts are penalty free if they go toward qualified higher education expenses for the IRA owner and/or his or her dependents. These qualified education expenses include tuition, fees, books, supplies and equipment required for the enrollment or attendance of a student at an eligible educational institution. An eligible educational institution is any college, university, vocational school or other post-secondary educational institution eligible to participate in the student aid programs administered by the Department of Education. These eligible educational institutions include virtually all accredited post-secondary institutions, whether public, nonprofit or proprietary (privately owned and profit making). The educational institution should be able to indicate whether it is an eligible educational institution. You can also click here for a list.
To Purchase a First Home
The IRA owner can make penalty-free distributions to purchase, build or rebuild a first home for:
The total distribution the IRA owner uses for first-time home purchases cannot exceed $10,000 during the IRA owner's lifetime. For married individuals, the $10,000 applies separately to each spouse, which means that the total for both is $20,000.
For Payment of an IRS Levy
The IRS may levy against an IRA, resulting in a distribution. The distributed amount is subjected to income tax, but the early-distribution penalty is waived.
The 10% early-distribution penalty does not apply to amounts that are not subject to income tax. These amounts include the following:
Distributions that occur on or after the IRA owner reaches age 59½ may be subject to income tax, but are generally not hit with an early-distribution penalty.
IRA distributions cannot be deferred indefinitely. An IRA owner must begin required minimum distributions (RMDs) for the year when he or she reaches age 70½, at which time the IRA owner may distribute the full balance of the IRA or distribute a minimum amount each year.
The first RMD must be distributed by April 1 of the year after the year in which the IRA owner reaches age 70½. For example, an IRA owner who reaches age 70½ in June of 2018, must take his or her first RMD by April 1, 2019. IRA owners must distribute the required minimum amount for each subsequent year by December 31 of that year. This means that if the IRA owner defers the first RMD until April 1 of the year after he or she turns 70½, the IRA owner would be required to take a second RMD in the same year.
The IRA custodian/trustee is required to calculate the RMD amount and notify the IRA owner or send an RMD reminder to the IRA owner with an offer to calculate the RMD amount upon request.
RMD amounts not distributed from the IRA by the due date are subject to a 50% excess-accumulation penalty.
The excess-accumulation penalty must be paid when the individual files his or her federal tax return. If the individual feels that the failure was due to reasonable circumstances, he or she may write to the IRS and request that the penalty be waived. If a waiver is being requested, the penalty is paid only if the IRS responds to say the request is deniedSEP IRAs: Conclusion