If you have an individual retirement account (IRA), 401(k) plan or other qualified retirement plan, you probably know about the penalties that occur if you withdraw your funds (also known as taking early distributions) before you reach age 59 1/2. Take the money out early and you will pay a 10% fee plus all applicable federal, state and local income taxes. The IRS does this to discourage people from using retirement savings on anything but retirement, but there are some cases in which the 10% penalty is waived for individuals or couples who qualify. Understand what these IRA early withdrawal penalty exemptions are and how to qualify for one.
Death: Sorry, I didn't mean to start things out on a bummer note. But it's true that if you pass away before retirement age, the distributions to your beneficiaries from your retirement account are not subject to the 10% penalty fee.
Permanent disability: If you become disabled and cannot work, you can access your IRA distributions early without paying a 10% penalty. You will need proof from a doctor confirming that you are physically or mentally unable to hold gainful employment.
Excessive medical expenses: If you are paying more than 7.5% of your adjusted gross income for medical expenses, you may be able to access your IRA without penalty. Just remember to save your receipts. Similarly, if you lose your job and are on unemployment without health insurance for more than 12 consecutive weeks, you can use distributions to pay for health insurance without penalty.
Education funding: If you use your withdrawals to pay for the education costs (including room, board, books, etc.) for you, a spouse, children or grandchildren, the distributions are not subject to the 10% penalty.
Buying a first home: You can use up to $10,000 from an IRA per person without penalty to buy your first home. You must spend the money within the first 120 days of the plan distribution or else you have to put the money back into your plan to avoid penalty.
Annuity payments: You can opt to have annuity to pay a series of distributions over time. It's complicated, and you have to get it just right to qualify for the exemption. So talk to a plan administrator or tax accountant before you choose this option.
IRS levies: Funnily enough, if you owe the IRS back taxes, you can access penalty-free IRA funds to pay them. Hey, at least it's an option.
Military reservist distributions: Individuals called to military duty for more than 120 days after September 11, 2001 get a special exemption from IRA early withdrawal penalties.
Rollover: Of course, if you rollover an IRA or 401(k) into another qualified retirement plan, it's not a taxable event and there is no additional penalty either. But you have to make a contribution to a rollover IRA within a 60 days of receiving a distribution.
For qualified retirement plans other than IRAs, there are some additional exemptions:
Leaving a job at age 55 or older: Distributions from your employer if you leave a job if it occurs in or after the year you turn 55. If you are a public safety worker in state or local government, this occurs during or after the year you turn age 50.
Divorce: Distributions made with a QDRO or Qualified Domestic Relations Order, which is used to separate retirement assets in a divorce.
ESOPs: Distributions of dividends in Employee Stock Ownership Plans.
If you are considering an IRA withdrawal in any of the above circumstances, contact a plan administrator or a tax accountant before making any moves. You want to follow all applicable regulations to avoid the 10% penalty.
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