In these uncertain times, there may be circumstances when you are forced to take an early distribution from your IRA, even though the contribution to the IRA is meant to provide you with additional income post retirement. An early IRA withdrawal would mean that you are under 59 ½ years of age. This, in turn, would invite not just a tax burden, but also a withdrawal penalty tax of 10%.
Situations where exceptions may be made to the “penalty payment” requirement while making an early withdrawal are explained below.
1. Purchasing a home
You can avail a penalty free withdrawal for as much as $10,000 in your entire lifetime towards expenses for building or rebuilding a first home or when purchasing a new home. This can include closing costs too. In circumstances where the applicant has not owned a home for two years in the past, in the eyes of the IRS, this becomes a first home. In the case of married couples, the spouse is allowed an additional $10,000. In addition to the spouse, eligible persons include you or your spouse’s child, parent, or grandchild. In the event of cancellation or a delay of purchase or construction, money put back into your IRA within 120 days of distribution will not invite a penalty.
2. Educational Costs
Spending the distribution to pay for higher education expenses will not invite a penalty. Individuals covered under this exception include you, your spouse, your and your spouse’s children, and grandchildren. Only specific colleges, universities, and vocational schools are covered under this category. Some post-secondary educational institutions come under the student aid programs administered by the U.S. Department of Education and are thus eligible for exemption in the payment of penalty. Books, fees, tuition, and supplies are covered under this expense. It is recommended that you consult your tax advisor and the educational institution to cover all the bases before making an application.
3. Serving in the Military
Military reservists called to active duty post September 11, 2001 for a period of 180 days or for an indefinite period qualify for distributions that are not subject to a penalty. These also include the Army Reserve, Marine Corps Reserve, Air National Guard, and Naval Reserve. The distribution should be made from an IRA or 403(b) account or attributed to elective deferrals under 401(k) plan and should be distributed during the period covering the active duty and not beyond the end of active duty.
4. Dealing with Disability
In the event of a physical or mental disability, where you are unable to work and the disability continues for an indeterminate period or may result in death; you will be allowed to withdraw from your IRA without paying the penalty. However, this has to be certified by a physician. Consulting your IRA custodian/trustee about the policy and procedures in this regard would be ideal.
5. Medical Expenses that cannot be reimbursed
Penalty-free distributions can be taken to pay for medical expenses in the absence of a health insurance cover or in the event of the medical expenses exceeding the insurance cover limit. Where medical expenses are in excess of 10% of your adjusted gross income for the year, exemption from penalty payment is limited to the excess amount.
6. Medical Insurance when unemployed
To pay for medical insurance in the event of unemployment, you can take distributions from your IRA without paying a penalty. Health insurance premiums for you, your spouse, and your dependents can be paid using distributions during the current year are penalty-free. A few conditions that apply to this situation is that the applicant has lost his/her job, received unemployment compensation for 12 continuous weeks under federal or state law and the distributions were received during the year the unemployment compensation was received or the following year. Where distributions were taken after regaining employment for about 60 days, the insurance cover amounts will not be exempt from penalty payment.
If you want to avoid penalties, one must make withdrawals before reaching age of 60 and also fulfill a few other conditions under which early IRA withdrawals are exempted from payment of penalty are the inheritance of IRA assets upon the death of the owner, payment towards IRS levies and taking substantially equal periodic payments (SEPPs) from your IRA.