The IRA is a great retirement savings vehicle; money grows on a tax-deferred basis and that’s a good thing. Eventually, though, you have to pay the IRS piper when you choose to withdraw funds for retirement or when you’re forced to withdraw the Required Minimum Distribution at age 73.
Let’s be clear. You can take money from your IRA anytime you want. Do it before age 59 ½ and you’ll pay taxes plus that nasty 10% early withdrawal penalty. But hidden in a dusty corner of the IRS code are 5 exceptions that allow you to take money before 59 ½ without paying the penalty.
Unreimbursed Medical Expenses
Unreimbursed is the keyword here. You can withdraw money from your IRA to pay unreimbursed medical expenses that exceed 7.5% of your Adjusted Gross Income (AGI).
For example, if your AGI is $100,000 and you have $10,000 in medical expenses not covered by insurance, you can withdraw $2500 without penalty. ($100,000 x 7.5%=$7500. $10,000 – $7500=$2500)
The unreimbursed expenses must be paid in the same year you make the IRA withdrawal.
Pay for Health Insurance
Even if your expenses don’t exceed 7.5% of adjusted gross income, you can take money out of your IRA to pay for health insurance if you lose your job and collect unemployment compensation for 12 consecutive weeks. The withdrawal can be used to pay for health insurance for you, your spouse, and your dependents. But there’s a time limit. The distribution to pay for health insurance must be made in the same year you received the unemployment compensation.
First-Time Home Purchase from Traditional IRA
The IRS definition of first-time home purchase means you haven’t owned a home in the past 2 years. It does not mean you’ve never owned a home. You can withdraw $10,000 without penalty toward the purchase. This is a lifetime limit. So, if you use the entire amount to purchase this house you won’t be allowed any more penalty-free IRA withdrawals for future home purchases. If you are married, your spouse can also withdraw $10,000 from their IRA. So, potentially you can put $20,000 toward a first-time home purchase.
While the withdrawal is penalty-free you will still pay taxes on the withdrawal as ordinary income.
Higher Education
Want to go back to school? You can withdraw funds without penalty for qualified expenses such as tuition, books, fees, and required supplies. You have to be enrolled in a qualified higher educational program and be in school at least half-time.
This exemption also applies if you’re helping a spouse or child with college expenses.
Inherited IRA Withdrawals
If you take money out of an IRA you inherited from someone, those withdrawals fall into the no-penalty zone. You have to have all the money out of the inherited IRA by the end of the 10th year after the death of the person you inherited it from. If not, then you will pay penalties.
Permanent Disability
If you’ve been classified as permanently disabled, penalty-free withdrawals from your IRA are allowed. You will have to show proof of permanent disability before you can withdraw.
Substantially Equal Payments
You can withdraw money from your IRA without penalty anytime at any age by using substantially equal payments or rule 72(t). The IRS will determine what amount you can receive each year based on your life expectancy. That’s the amount you must withdraw each year. Once you start substantially equal payments you can’t stop them until you’re 59 ½ or you’ve been taking the withdrawals for 5 years, whichever is longer. If you stop the withdrawals or change the amount of the withdrawal, you’ll get hit with the 10% early withdrawal penalty retroactively from the time you first began receiving the payments PLUS interest. Think long and hard before you choose this option.
Additional Options
If you put money into your IRA but then decide you need it back, you can generally “take back” one contribution made to a traditional IRA without paying tax, as long as you do it before the tax filing deadline of that year and do not deduct the contribution from your taxes.
You can also withdraw money from a traditional IRA and avoid paying the 10% penalty if you roll the money over into another qualified retirement account, such as a Roth IRA within 60 days. Going from Traditional to Roth is considered a conversion. There’s no early withdrawal penalty but you will have to pay income taxes on the amount you roll over.
Roth IRA Contribution Withdrawals
All the options above have been associated with Traditional IRAs. This one is about withdrawals from a Roth IRA.
Because Roth IRA contributions are made with after-tax money, the IRS allows you to withdraw that money without penalty at any time. If you choose this option be careful that you’re withdrawing contributions and not earnings on the money in the Roth. If you withdraw earnings before you’re 59 ½ you’ll likely be subject to the 10% early withdrawal penalty.
401(k) Withdrawals
401(k)s are not technically IRAs, but they are tax-deferred retirement savings accounts that have a penalty-free withdrawal option. If you leave or retire from your job between the ages of 55 and 59 ½ you can take withdrawals without paying the IRS penalty. But the money has to stay in the 401(k). If you roll it over into an IRA and begin taking withdrawals you lose the no-penalty option and will have to pay the early distribution penalty.
401(k) Loans
Borrowing money from your 401(k) does not incur a withdrawal penalty. You can borrow up to 50% of your account balance to a maximum of $50,000. But if you quit your job and have an outstanding loan balance, the IRS requires you to repay the balance within 60 days. If you don’t, the IRS classifies the balance as income for that year and you’ll pay taxes and a 10% penalty on the outstanding loan balance.
Even if you qualify for one of these penalty-free withdrawals, the IRS still wants its tax money. You’ll have to pay federal income tax on every withdrawal along with state taxes, unless you live in one of the nine states without an income tax—Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washington, and Wyoming.
Disclaimer
This information is presented for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy any investment products. None of the information herein constitutes an investment recommendation, investment advice or an investment outlook. The opinions and conclusions contained in this report are those of the individual expressing those opinions. This information is non-tailored, non-specific information presented without regard for individual investment preferences or risk parameters. Some investments are not suitable for all investors, all investments entail risk and there can be no assurance that any investment strategy will be successful. This information is based on sources believed to be reliable and Alhambra is not responsible for errors, inaccuracies, or omissions of information. For more information contact Alhambra Investment Partners at 1-888-777-0970 or email us at [email protected].
