What Are the Exceptions to the 10% Early Withdrawal Penalty?
Saver who make early withdrawals before age 59 1/2 may incur a 10% early withdrawal penalty; however, there may be exceptions.
The CARES Act eliminates early distribution penalties, but savers should still ensure they qualify. Some key exceptions to consider: terminal illness; medical expenses; IRS tax levies; adoption/birth of child and hardship situations.
Substantially Equal Periodic Payments (SEPPs)
Rather, if you need to tap retirement savings before age 59 1/2, the IRS permits a penalty-free withdrawal if funds are distributed evenly throughout a five year period or until age 59 1/2 is reached, whichever comes first. Usually this means withdrawing at least annually using one of three complex IRS calculation methods until reaching age 59 1/2; whichever comes first.
Calculation methods that require minimum distributions, amortizations, and annuitization create annual withdrawal amounts that fluctuate based on market changes in your account balance. It is wise to consult a financial professional in order to make sure your SEPP program stays within IRS parameters; once initiated it should remain ongoing for at least five years or until age 59 1/2.
Medical Expenses Payment
There are exceptions to the 10% early withdrawal penalty which could apply if you withdraw money from your retirement account for medical expenses, paying health insurance premiums after unemployment, satisfying IRS levies or due to disability – these are known as 72(t) exceptions.
Medical expenses cover expenses related to diagnosing, curing, treating or preventing disease or injury – including insulin injections, prescription drugs, X-rays, eyeglasses, nursing services and hospital care.
To qualify for the disability exception, you must be physically or mentally disabled enough that it prevents you from engaging in your customary gainful activity – this includes an expected length of at least 180 days or be of indefinite duration – as well as being present during distribution of benefits.
Eligible Higher-Education Expenses
Qualifications for higher-education expenses include tuition, fees, academic tutoring services, special needs services, books and supplies; room and board can also qualify if the student enrolls at least half-time; however computer software for gaming, sports or hobbies does not count as educational expenses.
Your qualified education expenses may qualify for above-the-line deductions and credits on your tax return, whether paid directly by you, your spouse or a dependent. In addition, the Lifetime Learning Credit may be applicable if they don’t lead directly to a degree but still advance job skills. In order to calculate this credit accurately, get Form 1098-TPDF Tuition Statement from each educational institution attended throughout the year where expenses were paid with cash, check or credit card and take into account that credits may be 40% refundable.
Hardship Withdrawals
If your employer authorizes it, a hardship withdrawal allows you to access retirement funds without penalty for unexpected financial needs that require immediate and urgent solutions. Your plan administrator can determine what constitutes a hardship withdrawal.
Medical expenses qualify as qualified expenses that you can use a hardship withdrawal to avoid paying penalties for. Your withdrawal must also occur within the same year that the expense was incurred to be eligible for this exception.
But a hardship withdrawal exposes your money to income taxes and does not get paid back or rolled over, thus depriving your retirement account of future earnings. Therefore, this option should only be utilized after all other options have been exhausted.
Home Equity Line of Credit
Home equity lines of credit (HELOCs) allow homeowners to leverage the equity in their property for cash, working like second mortgages to finance home improvement projects, education expenses or consolidate high-interest debt. HELOCs may also be used for debt consolidation.
HELOCs offer variable interest rates and repayment terms that differ between lenders. You also have a three-day right to cancel them (applies only if secured against your primary residence).
While taking out money from your retirement account may seem appealing in the short-term, it’s wise to carefully consider its long-term consequences before making this move. A withdrawal could drastically diminish future earnings while being very costly – consider consulting with your tax professional on possible alternatives before taking this route.
Categorised in: Blog