How Can I Avoid Paying Taxes on an Early IRA Withdrawal?
People who withdraw funds from their retirement accounts prior to turning 59 1/2 face a 10% tax penalty in addition to income taxes, but there are strategies available that could allow you to avoid this fee altogether.
Talk with a financial advisor about what options would work best for your circumstances – SmartAsset’s free advisor matching tool can help you find one!
1. Save for emergencies
An inherent drawback of investing in traditional individual retirement accounts or workplace plans like 401(k) is that any funds withdrawn prior to age 59.5 could incur an early withdrawal penalty of 10% in addition to income tax liabilities. There may be exceptions, though.
Slott notes that one common exception involves emergencies: If you can demonstrate “total and permanent disability”, the IRS permits penalty-free withdrawals from your IRA, according to her research.
There are exceptions for emergencies; you can withdraw contributions without tax penalties and tax liabilities if you’re out of work for more than 12 weeks, or medical expenses that exceed 7.5% of your adjusted gross income. Just make sure that any withdrawal is deposited back in your retirement account within 60 days or it will become taxable and subject to penalties; speaking with a financial adviser could help.
2. Use a Roth conversion ladder
If you’re planning to retire early, there are strategies available to you that can help avoid heavy withdrawal penalties down the line. One such strategy is called a Roth conversion ladder: this involves converting pre-tax money to Roth accounts which then allow withdrawals without penalty after five years since conversion.
Your goal should be to convert some of your retirement savings to Roth accounts each year, in order to access them tax free once nearing retirement. Converting when in a lower tax bracket may be optimal; but exactly when and how depends on individual situations.
An advisor or CPA can help you devise a financial strategy tailored specifically to your individual needs and circumstances, offering expert guidance in regards to investing. They’re also capable of thinking more long-term and may offer insights that you hadn’t considered previously – just make sure that they charge low fees without minimum account balance requirements!
3. Donate to charity
IRA owners over 70 1/2 can avoid early withdrawal penalties by making their required minimum distribution directly to charity. To do this successfully, however, your IRA custodian may require you to fill out a special form or present copies of checks from charities as proof of donation – ensure your chosen charity qualifies as a 501(c)(3) organization and request an acknowledgment letter as part of your tax records.
Nonitemizers can reduce their income tax liability on QCDs by deducting them in the year of creation if their adjusted gross income doesn’t surpass their adjusted gross income ceiling or carryover amounts from previous years. Consult a tax professional for guidance to best implement this strategy.
4. Buy a first home
Traditional, SEP or SIMPLE IRA withdrawals made before age 59 1/2 will generally incur taxes; however there are exceptions such as paying higher education fees penalty-free; unreimbursed medical expenses exceeding 7.5% of AGI; paying health insurance premiums should you lose a job; first-time home purchases etc.
To take full advantage of this exception, it’s essential that you create a comprehensive withdrawal strategy and adhere to it until age 59 1/2. Working with a tax professional will help ensure a plan that best meets your needs without costly errors or oversights.
Qualified longevity annuity contracts (QLACs), retirement annuities that allow access to funds without incurring an early withdrawal penalty of 10%, are another exception to this rule. Before considering this option however, be sure to speak to a trusted financial advisor first as its calculations could have serious repercussions if done incorrectly.
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