If you’re looking for some semi secret loophole to get money out of your IRA early, so you can spend it, think again. The tax code has that covered. The gist of the IRA early withdrawal penalty states that anyone under age 59½ who withdraws money from their IRA, is hit with a 10% penalty. Of course, the number one way to avoid the penalty is to wait until you’re old enough to get your money. That’s the point of an IRA in the first place – to keep the money there until retirement.
That said, the IRA rules have exceptions and exemptions where you won’t be penalized for taking money out early. Some are added benefits built into the IRA, others help with unforeseen hardship, and the IRS is very specific about each one.
1. First Time Home Buyer
One of the added benefits of IRAs is the ability to use a portion of the funds for a down payment on a home. Under the rules, first time home buyers have a lifetime limit of $10,000 ($20,000 for a married couple with separate IRAs) to use toward buying a house. There is a time limit once the funds are withdrawn. You’ll have 120 days, from the time you receive the funds, to buy your home.
This is where it gets interesting. The term “first time home buyer” refers to anyone who didn’t own a home in the past two years. For instance, say you’re looking to buy your second home and were renting the past two years. You’d be eligible if you haven’t used up your lifetime limit.
2. Higher Education
School costs are another IRA benefit. You’re allowed penalty free withdrawals if the money is used to pay for qualified higher education costs. That includes any school that meets the federal student financial aid requirements (colleges, universities, vocation schools).
So what are qualified higher education costs? It includes tuition, fees, books,and other supplies needed for coursework.
3. Substantially Equal Periodic Payments
The IRS understands that early retirement is an option. So you don’t have to wait till 60 to retire. The 72t distribution rules for substantially equal periodic payments is best used if you’re thinking about early retirement.
The rules state that you must withdraw equal payments for a minimum of five years or until you reach 59½, whichever comes later. There are other restrictions and extra paperwork involved if you go this route. Talk to a tax pro before hand.
4. Medical Expenses
Medical expenses not covered by insurance may be considered a hardship. It all depends on your adjusted gross income (AGI). First, those uninsured medical costs must be more than 7.5% of your AGI. If so, you can withdraw up to the difference between the medical costs and 7.5% of your AGI.
For instance, say you have $6,000 medical costs not covered by insurance and your AGI is $60,000. The $6,000 in medical costs are more than 7.5% of your AGI (7.5% x $60,000 is $4,500). In this case, you could withdraw the difference of $1,500 from your IRA penalty free.
5. Health Insurance Premiums
You can avoid the early withdrawal penalty if you’re unemployed and use withdrawn money to pay for health insurance premiums. Of course, it’s a bit more specific than that. You must be unemployed, receive federal or state unemployment benefits for twelve weeks, and receive the funds no later than 60 days after reemployment.
There’s a reason why we fill out beneficiary forms (it’s a good idea to double-check your IRA beneficiaries from time to time). When the owner of an IRA dies, the beneficiaries receive the IRA, known as an inherited IRA, and all the assets inside. As a beneficiary of an inherited IRA, you can withdraw funds penalty free at any time.
There is one exception for spouses. As a spousal beneficiary, you have the option to either leave it as an inherited IRA or move the IRA in your own name. There are benefits to doing both depending on your age. If you re-title it in your own name, it loses that “inherited” status and the benefits that go along with it.
The IRS is very specific about disability. If you are totally and permanently disabled, you can avoid the IRA early withdrawal penalty. You shouldn’t have any trouble proving it to the IRS if you already qualify for disability insurance or get disability benefits through social security.
One exemption is for military reservists that are called to active duty. As a reservist, you must be called to active duty for more than 179 days (at least 6 months). You can avoid the 10% penalty on any withdrawals made while you’re on active duty.
9. IRS Levy
The IRS has the ability to seize your property to pay your tax debt. In the case of your IRA, the IRS is kind enough to drop the early withdraw penalty on any funds it seizes from a levy.
Here’s one last thing to remember. Even if you escape the IRA early withdrawal penalty, there’s a chance of being hit by federal and/or state taxes too. Weigh your options carefully and talk to a tax pro if you’re not sure.