By doing a thorough job of research and getting good advice on early withdrawls, you can be dressed for success.
Can you withdraw money early from your IRA without paying penalties? If you dip into your retirement assets early, you may find that substantial taxes and other financial disincentives erode the value of your distribution. On the other hand, if you are facing difficult financial circumstances or unforeseen expenses, withdrawing money from your IRA could be a viable choice. Understanding the tax rules that govern early withdrawals can help you successfully navigate these challenging situations.
A closer look at early withdrawals
Generally, you can take penalty-free distributions from your traditional IRA after you reach age 59 ?. However, you must still pay all federal and state income taxes due on any withdrawals.
Before age 59, you may have to pay a tax penalty on early withdrawals, in addition to the income taxes you owe on these distributions, unless you qualify for an exception. This early-withdrawal tax penalty equals 10 percent of the taxable amount withdrawn.
Neither income taxes nor the early withdrawal penalty apply if you follow IRS guidelines for rollovers or direct transfers of your IRA assets to another retirement plan.
Escaping the early-withdraw penalty
To avoid early-withdraw concerns, there are exceptions that may suit your financial situation. For traditional IRAs, exceptions include:
Education expenses — Expenses incurred at qualifying educational institutions (colleges, universities, vocational schools and other post-secondary facilities that meet federal student aid program requirements) qualify for the exception. Eligible educational expenses include tuition, fees, books, supplies and equipment, as well as room and board if the student is enrolled at least half time in a degree program. These expenses can be for you, your spouse, children or grandchildren.
First-time home purchase — If you are buying or building your first home or haven’t purchased a home in at least two years, you may withdraw up to $10,000 from your IRA without incurring an early-withdrawal penalty. If you are married, you and your spouse can each withdraw $10,000 without penalty from individual IRAs. Other eligible individuals include your or your spouse’s child, your or your spouse’s grandchild, your or your spouse’s parent or other ancestor. There is a $10,000 lifetime limit withdraw per person.
Medical expenses — Certain medical expenses that are not reimbursed are exempt from the early withdrawal tax if they exceed 7.5 percent of your adjusted gross income (AGI).
Medical insurance — You may take penalty-free distributions from your IRA to pay for your medical insurance after 12 consecutive weeks of unemployment.
Disability — If you have a total, permanent mental or physical disability and are unable to work, you are eligible for penalty-free distributions from your IRA.
Inherited retirement assets — After your death, your beneficiaries and your estate may receive distributions that are not subject to early-withdrawal penalties.
Qualified reservists — IRA distributions made after Sept. 11, 2001, and before Dec. 31, 2007, are not subject to the 10 percent penalty for qualified reservists called to active duty.
Substantially equal periodic payments — You can make distributions from a traditional IRA before age 59 without the 10 percent penalty if your withdrawals are part of a series of equal payments based on your life expectancy or the joint life expectancies of you and your beneficiary. You must use an IRS-approved distribution method and take at least one distribution annually. Once the distributions begin, they must continue for a period of five years or until you reach age 59, whichever is longer.
Points to keep in mind
While you may not have to pay the early-withdrawal penalty on certain distributions from traditional IRAs, you will need to pay federal and state income taxes.
With the early-withdrawal penalty, you may be required to file additional forms along with your income tax return.
Distributions from an IRA are subject to federal income tax withholding; however, since distributions are commonly more than 10 percent additional tax, your withholding may not be enough. You may need to make estimated tax payments.
Consider the real costs of making an early withdrawal from your IRA. A $10,000 withdrawal does not equal $10,000 in your pocket. If you are under age 59, you could lose as much as 35 to 45 percent of your withdrawal in taxes and penalties.
Seek specialized help
You can avoid paying penalties on early withdrawals from IRAs in certain situations if you meet IRS guidelines. However, in many cases, the requirements are complex. A financial advisor can help you implement these guidelines and assess whether an early IRA withdrawal will benefit your financial situation.
This information is provided for informational purposes only and is intended to be generic in nature and should not be applied or relied upon in any particular situation without the advice of your tax, legal and/or your financial advisor.
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