How Can I Avoid Paying Taxes on an Early IRA Withdrawal?
Savers typically incur a 10% early withdrawal penalty when taking money out of their retirement accounts before age 59 1/2, but there may be instances in which account owners can access funds without incurring this additional fee.
One exception applies to first-time homebuyers using substantially equal periodic payments as their distribution method, though navigating it may be tricky and the assistance of a financial advisor would likely be needed for success.
1. Withdrawals for Medical Expenses
Retirement savers may be able to gain access to their IRA funds without incurring penalties if they use it to cover certain expenses; however, doing so requires careful timing and may lead to additional income taxes being due; for instance if withdrawing for unreimbursed medical expenses then distribution should occur in the same year that expenses occurred or else penalties will apply.
Rothstein states that investors may use penalty-free withdrawals from their IRAs to cover health insurance premiums if they’ve been unemployed for at least 12 weeks and receiving unemployment compensation payments. He suggests opening a separate bank account to receive withdrawals before spending them to cover premium payments.
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2. Withdrawals for Unemployment Compensation
Sometimes a traditional or Roth IRA allows for penalty-free withdrawals. For instance, your first Required Minimum Distribution (RMD) after turning 701 can be taken penalty free if used to cover unreimbursed medical expenses that exceed 10 percent of adjusted gross income.
Withdraw funds without incurring penalties when paying qualifying higher education costs for yourself, your spouse, children or grandchildren; additionally you may withdraw up to $10,000 without penalties if using them to purchase your first home.
Finally, to avoid penalties you can withdraw funds from your IRA to pay unemployment compensation insurance for you, your spouse, or dependents. But always consult with a reliable tax professional before withdrawing money from your retirement account as any mistakes could cost you dearly.
3. Withdrawals for Education
An IRA account can be an ideal source of education funding. Any withdrawals for education expenses qualify penalty free; such expenses include tuition fees, books and equipment required to enroll at an approved educational institution – with room and board included for full-time students.
The education exception can only be used to pay for education expenses related to an IRA owner and spouse or their child or grandchild (i.e. siblings, nieces and nephews don’t qualify). Furthermore, distributions must take place during the same year that qualified expenses have been incurred.
Taxes can be complex, making mistakes easy to make that could cost you dearly. If you need assistance managing your IRA investments or avoiding taxes on an early IRA withdrawal, hiring a financial advisor might be worth your while – licensed professionals often possess longer-term strategies than software programs and may know of ways to reduce taxes by withdrawing early from an IRA account early. Fill out our questionnaire and we’ll pair you up with one!
4. Withdrawals for Health Insurance
The CARES Act permits retirement savers to withdraw funds without penalty for certain health-related expenses, specifically unreimbursed medical expenses that exceed 10% of your adjusted gross income in the year of distribution. Furthermore, new parents can withdraw up to $5,000 of birth and adoption expenses penalty-free from their retirement accounts.
Saver who want to access their retirement savings early can avoid incurring penalties by withdrawing for one of seven reasons.
The IRS also provides other means of avoiding penalties, such as using retirement account funds to purchase your first home or buying qualified disability insurance policies. As tax rules can be complex and you should consult with a financial advisor for guidance; our questionnaire can assist in connecting you with advisors from our network who provide personalized advice tailored specifically for your unique situation.
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