Withdrawing money from your traditional Individual Retirement Account (IRA) before the age of 59½ often comes with a penalty. Taxpayers will be assessed a 10% penalty, along with income tax in most cases, on early withdrawals. However, there are certain exceptions that allow individuals to take money out of their IRA early without paying the penalty. Here are nine ways to make penalty-free early withdrawals from your traditional IRA.
1. Unreimbursed medical expenses:
When your medical costs exceed 7.5% of your AGI and are not covered by insurance, you can make a penalty-free withdrawal. You don’t have to itemize your taxes to take advantage of this exception.
2. Health insurance premiums:
Unemployed individuals can use their IRA funds to pay for health insurance for themselves, their spouses, or dependents. To qualify, they must have received unemployment compensation for 12 consecutive weeks, take the distribution either in the year they received unemployment or the year after, and receive the withdrawal before being re-employed for 60 days.
3. College expenses:
Tax-free withdrawals from an IRA can be used for the account holder’s, their spouse’s, or their child’s qualified college expenses. This includes tuition, fees, books, supplies, equipment required for enrollment, and some special needs services. Participation in government student aid programs is required by the educational institution.
Individuals who become disabled can withdraw from their IRA at any time for any reason without paying the penalty. Proof of disability from a physician may be required.
5. Home purchase or renovation:
A first-time homebuyer may withdraw up to $10,000 from his or her IRA for purchasing, building, or renovating a home. The IRS defines “first-time” as not having owned or built a principal residence within the previous two years. The funds can also be used to assist children, grandchildren, or parents who meet the first-time homebuyer criteria.
6. Birth or adoption of a child:
Parents may withdraw up to $5,000 from their IRAs without penalty within one year of the birth or adoption. Couples can withdraw a total of $10,000 from separate accounts. The withdrawals can be repaid without affecting annual contribution limits.
7. Military reserves:
Reservists who have been called to active duty for more than 179 days can make penalty-free IRA withdrawals during their period of active duty.
8. Inherited IRAs:
Non-spousal beneficiaries who inherit a traditional IRA are allowed to make penalty-free withdrawals before age 59½. As required by the SECURE Act, beneficiaries must empty their inherited IRAs within a decade of receiving them.
9. Special payments:
Penalty-free withdrawals are allowed for Special Equal Periodic Payments (SEPP). Under these plans, individuals can receive regular annual distributions for five years or until they reach age 59½, whichever comes later.
Before considering an early IRA withdrawal, it’s important to keep a few points in mind. Individuals will still owe taxes on the withdrawn amount, so it’s crucial to factor in the tax bill when deciding how much to withdraw. It’s also essential to thoroughly understand the rules associated with each withdrawal scenario to avoid incurring the 10% penalty. Furthermore, early withdrawals can deplete retirement savings and limit the potential earnings growth of those funds.
Considering other sources of funds and exploring options like a loan from an employer-sponsored 401(k) before withdrawing from an IRA can help replenish savings and minimize the loss of earnings growth.
While penalty-free IRA withdrawals can be beneficial in certain hardship scenarios, it’s crucial to follow the rules carefully and plan for any tax implications that may arise.