An IRA is one of the most important retirement investments that you can have. It allows you to take deductions on your contributions while accumulating tax-deferred earnings.
You are generally not allowed to withdraw money from a traditional IRA until age 59-1/2 without paying a 10% penalty on top of ordinary income taxes on your withdrawal — and generally you do not want to withdraw funds early because of the loss of tax benefits and the reduction in earnings.
However, there are cases where you may legitimately need to access your IRA funds, and the IRS has made exceptions to the early withdrawal rule to account for these cases. These exceptions are sometimes known as Rule 72(t) provisions after the applicable section of the Internal Revenue Code. Here are some of the primary allowable exceptions:
1. Initial Home Purchase – For purposes of buying or building/rebuilding your first home, you can take a penalty-free early IRA withdrawal up to $10,000 or $20,000 for couples. To qualify as a "first home," you and your spouse must not have owned a home for two years prior to the home sale.
2. Medical Expenses – You can withdraw funds penalty-free to pay for any unreimbursed medical expenses that go beyond 10% of your adjusted gross income (AGI) for the tax year. The withdrawal must take place during the same year as the medical expense.
3. Disability – Should you become disabled, you can qualify for the early withdrawal exemption if your disability meets severity requirements.
4. Health Insurance – If you have been unemployed for at least twelve weeks because of the loss of a job, you can take penalty-free early withdrawals to pay for health insurance for you and your family. Make sure that the distribution is in either the same year or the following year after receipt of unemployment benefits.
5. Revise to an Annuity – It is possible to avoid a penalty by setting up your withdrawals as a series of annuity payments that are calculated according to your life expectancy. You must take the distributions for five years or until you reach age 59-1/2. The withdrawal method must follow IRS-approved guidelines, so it is wise to seek professional help when choosing this path.
6. Educational Expenses – Certain payments on higher education expenses may be covered by penalty-free IRA withdrawals if the educational institution qualifies and other requirements are met. Contact a tax professional and your school to verify if your educational expenses apply.
7. Inheritance – When you inherit an IRA, you can take withdrawals without the 10% penalty, but you must leave it as the inherited IRA instead of rolling it over into your own. Once rolled over, an IRA is treated as your own and subject to the same rules as your existing IRA.
For a full list of exceptions and further information, check the IRS website.
Roth IRAs (established using after-tax funds) work a bit differently with respect to penalties. The contributions that you have made may be withdrawn at any time tax-free and penalty-free. Penalties only apply on earnings if the withdrawal takes place less than five years after the initial IRA deposit and you are below age 59-1/2.
The same exceptions that apply to traditional IRAs apply to Roth IRAs in this case, but if the withdrawal takes place after the five-year mark, penalties do not apply even if you are below age 59-1/2. Taxes apply on the earnings withdrawn before the five-year mark regardless of your age.
We suggest that you keep all of your IRA funds in place whenever possible. However, if you truly need to access your IRA funds, see if your reasoning falls under one of the Rule 72(t) provisions — and if it doesn't, then you will have to decide if the need is strong enough to be worth absorbing a tax hit and the corresponding 10% penalty.
Let the free MoneyTips Retirement Planner help you calculate when you can retire without jeopardizing your lifestyle.