Can I Cash Out My IRA Before 59 1/2?
IRAs are designed to help save for retirement. The IRS imposes strict rules and penalties that discourage withdrawing funds before age 59 1/2.
Good news – the IRS does offer exceptions. Here are a few examples: If your unreimbursed medical expenses exceed 7.5% of adjusted gross income or you are called up as military reserve personnel to active duty; or are the beneficiary of an IRA owned by someone who died; all may qualify.
Taxes
Withdrawals from traditional, SEP, and SIMPLE IRAs you own are fully taxable unless nondeductible contributions were made to them. They must be included as income in your taxable income for that year; under certain circumstances they can trigger an additional 10% penalty tax, and an exception could trigger one as well. Consulting a trusted tax advisor may help ensure you minimize being moved into higher tax brackets when taking distributions wisely.
The rules governing individual retirement accounts (IRAs) require your IRA custodian to withhold at least 10% of any withdrawal, unless you waive withholding or make an election to have more withheld. Once withdrawals occur, an IRS Form 1099-R will be generated showing how much was withheld as well as providing other information you need for filing your 2023 tax return.
Penalties
An early withdrawal penalty can wreak havoc with your savings account, but there may be exceptions depending on how the money entered your account and your age.
Typically, withdrawing pretax contributions prior to age 59 1/2 will incur a 10% penalty and taxes; however, in certain situations these funds can be accessed free of any penalties.
One exception applies if you are receiving payments over your lifetime (similar to an annuity), or are the beneficiary of a deceased IRA owner. Other exceptions allow penalty-free withdrawal of IRA funds for unreimbursed medical expenses or to purchase, build, or rebuild your first home.
Another way that may allow you to access your IRA funds penalty-free is if they’re needed to satisfy an IRS levy. But please be mindful of not using it as justification for withdrawing them for other reasons – consult both the IRS and financial advisor before taking any withdrawals from an IRA account.
Rules for Early Withdrawals
Under most circumstances, the IRS taxes and penalizes any distributions from traditional and Roth IRAs made prior to reaching age 59 1/2.
Withdrawals used to cover qualifying higher education expenses incurred by an account owner, their spouse, or children is exempt from incurring the 10% penalty. Qualified expenses include tuition fees, books and supplies as well as room and board for students attending more than half-time courses.
You can avoid incurring penalties by withdrawing funds to help buy your first home, and also use an IRA account for medical costs without incurring penalties.
Avoiding penalties requires taking substantially equal payments (SEPPs) from your IRA over your lifetime or until age 59 1/2, using an IRS approved method. Furthermore, any money withdrawn must be returned within 60 days to avoid incurring further fees and penalties.
Borrowing From Your IRA
If you own an IRA, indirect rollover may allow you to temporarily use its funds without incurring taxes or penalties. This option involves withdrawing cash from one retirement plan and placing it into another qualified plan within 60 days – an ideal solution for those needing short-term access to their funds without disrupting their investing plan too significantly.
Keep in mind, though, that anytime you withdraw money from an IRA you forfeit compound interest earnings and income tax deferral benefits. Furthermore, any money taken out must be replaced within 60 days – something which can be challenging – to avoid taxes and penalties; failing which you may find yourself facing unpleasant tax liabilities and penalties. IRAs cannot be used as collateral against loans (this applies even for inherited IRAs).
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