When Can You Withdraw Money From Your IRA Without Incurring the 10% Penalty?
There may be occasions when withdrawing money from your IRA without incurring the 10% penalty in order to meet unexpected expenses. Speak with a trusted tax professional regarding all of your options.
Your IRA allows you to withdraw funds without incurring a 10% penalty when used to cover uninsured medical expenses or health insurance premiums for you, your spouse and/or children up to 7.5% of adjusted gross income.
1. Qualified Education Expenses
With higher education costs rising quickly, many parents and students alike are turning to retirement savings accounts like IRAs and employer-sponsored plans such as 401(k)s as a source of relief. According to a 2020 Sallie Mae and Ipsos survey, 14% of respondents reported withdrawing money from these savings vehicles to cover tuition costs.
Ordinarily, anyone taking distributions from their IRA prior to age 59 1/2 must pay the 10% early withdrawal penalty. However, there are exceptions which allow you to avoid this tax when withdrawing funds for qualified education expenses.
The Internal Revenue Service defines qualified education expenses as tuition and fees, books, education-related supplies and equipment and room and board expenses associated with eligible postsecondary institutions such as vocational schools, for-profit colleges or universities which qualify to participate in government student aid programs.
2. First-Time Home Purchase
An IRA is intended for retirement savings, so any withdrawals before age 59 1/2 may incur income taxes and the 10% penalty; with certain exceptions such as when purchasing your first home.
This program allows you to withdraw funds to cover the costs associated with buying, building or rebuilding a first home, as well as “usual and reasonable settlement, financing and closing expenses”. You may use this money for yourself, your spouse or any qualifying family members.
The homebuying exception can apply to both traditional IRAs and Roth IRAs, which are taxed differently than their traditional counterparts. But it only applies if you qualify as a first-time homebuyer and can prove it. Furthermore, your funds must be returned within 120 days.
3. Hardships
Though raiding your retirement account early is never ideal, life sometimes forces us to do so when financial circumstances turn dire. Luckily, the IRS offers “hardship withdrawals” on certain types of retirement accounts (traditional and Roth IRAs) so individuals may withdraw funds prior to turning age 59 1/2 without incurring the typical 10% penalty fee.
However, the IRS applies stringent criteria to these distributions in order to ensure they only fulfill genuine financial needs. If you take out a hardship withdrawal to pay medical expenses, taking that action could affect future federal financial aid eligibility.
In such circumstances, it could be wise to open up a 529 college savings plan instead. These state-sponsored plans offer similar tax-free withdrawals when used towards qualified education expenses.
4. Taxes
Social Security payments alone rarely cover all the expenses of retirement, which means some retirees need to withdraw early from their IRAs in order to meet expenses. Unfortunately, doing so can trigger the 10% penalty; unless an exception applies instead.
First-time home buyers can use penalty-free IRA withdrawals to cover “qualified acquisition costs”, such as those related to purchasing, building, or rebuilding their property. Furthermore, qualified medical expenses exceeding 7.5% of adjusted gross income can also be covered through penalty-free withdrawals from an IRA.
The “substantially equal periodic payment” exception allows retirees to take out small sums annually based on their life expectancies or joint life expectancies, with any deviation voiding this exception and incurring income taxes and penalties. Consulting a trusted tax professional is recommended when setting your payment plan.
5. Military Reservists
Individual Retirement Accounts (IRAs) are tax-advantaged savings accounts that allow individuals to postpone paying taxes on earnings until retirement. There are three main types of IRAs: traditional, Roth and SEP.
Countries which impose conscription may obligate citizens to serve in the reserves once their enlistment or commissioning period ends, often for months or even years thereafter. Reservists can be called up during wartime for active service – both during active battle as well as reserves being called back up during peacetime operations.
Applicant must be 17 or over and pass an Armed Services Aptitude Battery exam that encompasses four essential areas – arithmetic reasoning, math, word knowledge and paragraph comprehension. They must also pass a physical exam. Applicants typically train on specific weekends each month and two weeks annually.
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