An individual retirement account (IRA) provides tax incentives to save this year’s income and not touch it until you retire. But what if you have an emergency and need money today. Are their ways to take a penalty-free early IRA withdrawal?
The answer is yes, you can withdraw money from an IRA early, but not without consequences.
If you make an unqualified withdrawal before age 59 ½ from a traditional IRA you’ll owe income taxes plus a 10 percent penalty. If you withdraw money early from a Roth IRA, you’ll only pay taxes and penalties on the account’s earnings, not the principal.
The early withdrawal penalties serve as additional motivation to keep your money invested for as long as possible, but sometimes you’re faced with challenges that leave you little choice.
There are, however, a few ways you can take money out of your IRA before you’re 59 ½ and avoid paying a penalty.
You are allowed to take a distribution to cover qualified higher education expenses without incurring a penalty. What’s more, the costs can be for you, your spouse, or your children. Keep in mind that this exception only applies to costs already incurred and shouldn’t be used as an alternative to proper college savings accounts like 529’s and Coverdell accounts.
The costs associated with even a relatively small medical emergency can be catastrophic for most people. In fact, unpaid medical bills are the number one reason American’s have to claim bankruptcy.
The IRS states that if you have medical expenses greater than 10 percent of your adjusted gross income (AGI), then anything in excess of that percentage can be withdrawn from an IRA without paying a penalty tax.
First-time Homeowners’ Exception
Buying a home is generally the largest single purchase you will make in your lifetime and usually requires a down payment that can take many years to save up for. As long as you need $10,000 or less, you can make a penalty-free withdraw. If you’re married, you can combine the benefit for a total available withdrawal of $20,000.
Substantially Equal Periodic Payments
If you need to create an income stream before you retire, you can set up substantially equal periodic payments (SEPP) to avoid the 10 percent early withdrawal penalty. This SEPP method can be complicated to properly calculate and shouldn’t be attempted without using a tax professional, but essentially it allows you to make withdraws until you’re 59 ½ or for 5 years, whichever comes later.
This means that you could be committing to a withdrawal plan for many years if you exercise it when you’re younger. Also, if you don’t stick to the withdrawal rules very carefully, you could end up owing a 10 percent on every withdrawal you made — resulting in a significant tax bill.
If you become either physically or mentally disabled where you can no longer sustain gainful employment, you are allowed to make penalty-free withdraws before age 59 ½. The disability must be expected to last for a long time although it technically does not have to be permanent.