Keep your 10%.
Distributions from individual retirement accounts before age 59 1/2 typically trigger a 10% early withdrawal penalty. However, the IRA withdrawal rules contain several exceptions to the penalty if you meet certain circumstances or spend the money on specific purchases. Here are 12 ways to avoid the IRA early withdrawal penalty.
Delay IRA withdrawals until age 59 1/2.
You can avoid the early withdrawal penalty by waiting until at least age 59 1/2 to start taking distributions from your IRA. Once you turn age 59 1/2, you can withdraw any amount from your IRA without having to pay the 10% penalty. However, regular income tax will still be due on each IRA distribution. You can continue to defer paying income tax on the funds in your IRA until you withdraw the money from the account. Traditional IRA distributions are not required until after age 72.
An IRA withdrawal for medical expenses
You may not need to pay the 10% penalty on an early IRA withdrawal if you use the money for major health care costs. IRA distributions used to pay for medical expenses that are not reimbursed by health insurance and exceed 10% of your adjusted gross income are not subject to the early withdrawal penalty. To find out the maximum amount you could withdraw from your IRA without penalty, add up the amount you paid for unreimbursed medical expenses in the year you took the distribution and subtract 10% of your adjusted gross income for the same year. You don’t have to itemize your taxes to take advantage of the penalty exception for medical costs.
An IRA withdrawal to pay for health insurance
Unemployed individuals may be able to take early IRA withdrawals without penalty to cover the cost of health insurance premiums. If you lose your job and collect unemployment compensation for 12 consecutive weeks, you can take penalty-free IRA distributions if you use the money to pay for health insurance for you, your spouse or dependents. To qualify for this penalty exception, you must take the distribution in the year you received the unemployment compensation or the following year, and before you have been re-employed for 60 days or more.
An IRA withdrawal for college costs
Penalty-free IRA distributions are allowed to pay for college. Eligible expenses include tuition, fees, books, supplies and equipment. Room and board also count if the individual attending college is at least a half-time student. The education must be for the account owner, his or her spouse, or their children or grandchildren. Qualifying institutions include colleges, universities and vocational schools eligible to participate in federal student aid programs. However, IRA withdrawals are considered taxable income and could reduce the student’s eligibility for financial aid.
An IRA withdrawal for a first home purchase
An early IRA withdrawal can be used to help fund a first home purchase. You can withdraw up to $10,000 ($20,000 for couples) from an IRA to buy or build a first home without incurring the early withdrawal penalty. To qualify for the exception, you must not have owned a home for the two years preceding the home purchase. If the purchase or construction of your home is canceled or delayed, put the money back in your IRA within 120 days of the distribution to avoid the penalty. This type of early IRA withdrawal can also be used to help purchase a first home for a child, grandchild or parent.
An IRA withdrawal following the birth or adoption of a child
Parents of newborns are eligible to take penalty-free IRA distributions. IRA owners can withdraw up to $5,000 without penalty following the birth or adoption of a child. The distribution must be taken within one year of a child’s birth or adoption. If financial circumstances improve, parents have the option to put the money back into the account to accumulate for retirement.
An IRA withdrawal to pay for a disability
People with severe physical and mental disabilities who are no longer able to work can take IRA withdrawals without penalty. You may need to provide documentation that you are unable to participate in gainful activity due to your condition. A physician will need to determine the severity of the disability. Conditions that qualify for the penalty exemption are generally expected to be of long, continued or indefinite duration and result in death.
An IRA withdrawal for military service
Members of the military reserves who take an IRA distribution during active duty do not have to pay a 10% penalty on the amount withdrawn. The penalty exception is available to those ordered or called to duty after Sept. 11, 2001, for a period of more than 179 days. The distribution must be taken during the active duty period to avoid the penalty. Qualified reservist distributions may be available to members of the Air Force Reserve, Air National Guard of the United States, Army National Guard of the United States, Army Reserve, Coast Guard Reserve, Marine Corps Reserve, Naval Reserve or Reserve Corps of the Public Health Service.
Set up an annuity.
IRA withdrawals taken as a series of annuity payments are not subject to the early withdrawal penalty. The use of an IRS-approved distribution method and at least one withdrawal annually are required to avoid the penalty. The payments are calculated based on your life expectancy or the joint life expectancies of you and your beneficiary, and generally require professional assistance to calculate. If you don’t consistently withdraw the correct amount over the appropriate number of years, penalties could be applied.
A Roth IRA withdrawal
A Roth IRA early withdrawal often has fewer restrictions and penalties than a traditional IRA distribution if you need access to your retirement savings before age 59 1/2. You may be able to withdraw your contributions, but not the earnings, from a Roth IRA that is at least five years old without incurring the early withdrawal penalty. A 10% early withdrawal penalty could be applied to early distributions of investment earnings. Unlike a traditional IRA, you typically won’t owe income tax on Roth IRA distributions. Roth IRAs also don’t require you to take distributions after age 72.
An inherited IRA
If you inherit a traditional IRA before age 59 1/2, you can take penalty-free withdrawals, but you will need to pay income tax on each distribution. If the original account owner passed away after Jan. 1, 2020, you will be required to withdraw all assets from the inherited IRA within 10 years of the IRA owner’s death, unless you are a surviving spouse, minor child, disabled, chronically ill or up to 10 years younger than the original account owner. However, if you inherit an IRA from your spouse and elect to treat it as your own, distributions before age 59 1/2 will be subject to the early withdrawal penalty.
Leave the money in a 401(k).
Workers who leave their jobs in the year they turn 55 or older can withdraw money from their 401(k) without having to pay the 10% penalty. Qualified public safety employees can begin taking penalty-free withdrawals if they leave service in the year they turn 50 or older. But if that money is rolled over to an IRA, you will have to wait until age 59 1/2 to avoid the penalty, unless you qualify for one of the other early withdrawal penalty exceptions. If you will need the money in your 401(k) plan between ages 55 and 59 1/2, you should delay rolling the money over to an IRA in order to avoid triggering the early withdrawal penalty.
How to avoid the IRA early withdrawal penalty:
— Delay IRA withdrawals until age 59 1/2.
— Use the funds for large medical expenses.
— Purchase health insurance after a layoff.
— Pay for college costs.
— Fund part of a first home purchase.
— Defray birth or adoption costs.
— Manage disability expenses.
— Cover the cost of military service.
— Set up an annuity.
— Consider a Roth IRA withdrawal.
— Take a distribution from an inherited IRA.
— Leave the money in a 401(k).
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12 Ways to Avoid the IRA Early Withdrawal Penalty originally appeared on usnews.com
Update 12/27/22: This story was previously published at an earlier date and has been updated with new information.
