What Are the Exceptions to the 10% Early Withdrawal Penalty?

What are the exceptions to the 10 early withdrawal penalty

Assuming no exception applies, withdrawals made before age 59 1/2 from tax-advantaged retirement accounts will incur an additional 10% tax in addition to ordinary income taxation.1

The Tax Code offers 16 exceptions to penalties; some have narrow definitions. Here are the most frequent ones: 1. Withdrawals made for medical expenses.

1. Withdrawals for Medical Expenses

The tax code provides 16 exemptions to the 10% early withdrawal penalty imposed upon early withdrawals from retirement accounts, some universal while others only applicable to IRAs and employer-sponsored plans like 401(k)s and 403(b). Some examples include medical expenses, health insurance premiums following unemployment, substantially equal periodic payments (SEPPs) and IRS levies.

The medical expense rule is an especially generous one, permitting savers to use their IRA funds for out-of-pocket medical expenses exceeding 7.5% of their adjusted gross income that are incurred during the same year they withdraw money from their account. However, these expenses must occur prior to receiving distributions.

This distinction is critical, because it allows IRA hardship withdrawals to pay for medical procedures that occur this year if they’re due next year. You should report this withdrawal on your federal income tax return using Form 5329 in order to claim this exception; additionally, these expenses must pertain directly to either yourself, your spouse or dependent children who qualify as dependents.

2. Withdrawals for Eligible Higher-Education Expenses

If you withdraw money from your retirement account for eligible higher education expenses such as room and board, tuition fees, books and equipment rental expenses then the 10% penalty does not apply.

The IRA withdrawal exception applies to any type of IRA, such as traditional, Roth, and SEP IRAs. However, if required to take annual minimum distributions (RMDs) after age 72 from an IRA account, any portion considered account earnings would be subject to penalty charges.

Avoiding penalties requires setting up a series of payments that last your entire lifetime or that of you and a beneficiary, using one of three IRS-approved methods and starting before reaching age 59 1/2.

3. Withdrawals for First-Time Homebuyers

Typically, when withdrawing funds from an IRA before age 59 1/2, you will owe income tax and an early withdrawal penalty of 10% unless an exception applies; several types of withdrawals such as first-time homebuyer purchases and disability withdrawals do not incur this charge.

IRS rules permit withdrawals from an IRA without incurring the 10% penalty if you purchase, build, or rebuild your first home within two years and use these funds for qualified acquisition costs.

SEP IRA withdrawals made to buy or build your first home can also avoid penalties; you simply need to use all funds within 120 days for qualified acquisition costs – you’ll then need to provide your mortgage company with proof that this requirement was met.

4. Withdrawals for Disability

IL ABLE Accounts provide withdrawals to cover a range of Qualified Disability Expenses that improve quality of life, health and independence of Account Owners. They must be approved by an Account Owner or authorized individual before spending. Any withdrawal used for non-qualified expenses will be taxed at ordinary income rates and could affect eligibility for SSI benefits or Medicaid eligibility.

There are a few exceptions to the 10% early withdrawal penalty that apply universally across both QRPs and IRAs, such as attaining age 59 1/2, death, disability, substantially equal periodic payments (known as 72(t) payments), IRS levies, ESOP dividends, medical expenses and first-time homebuyer expenses; as well as special considerations applicable only to QRPs such as alternative payee distributions and corrective distributions. Certified public accountants or enrolled agents can help to determine eligibility; best resources include certified public accountants or agents.

Raymond Banks Administrator
Raymond Banks is a published author in the commodity world. He has written extensively about gold and silver investments, and his work has been featured in some of the most respected financial journals in the industry. Raymond\\\'s expertise in the commodities market is highly sought-after, and he regularly delivers presentations on behalf of various investment firms. He is also a regular guest on financial news programmes, where he offers his expert insights into the latest commodity trends.

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