Early Withdrawal Penalty Exemptions on IRAs

IRAs aren’t just for retirement anymore. You can use proceeds from your IRA to cover a wide range of specific expenses, and the dreaded 10% early withdrawal penalty will not apply. You will still have to pay the regular income tax on the distribution in most cases, but since you most likely got a deduction as a result of the contribution, this is only fair.

Here are some of the more common early withdrawal penalty exemptions for IRAs.

1. Withdrawals made after you turn 59 ½.

Withdrawals taken from an IRA after you turn 59 ½ are not subject to the 10% early withdrawal penalty. For Roth IRAs, there is an additional requirement that the account must have been in existence for at least five years prior to the withdrawal.

All other exemptions listed below will enable you to withdraw money from your IRA penalty-free even before turning 59 ½.

2. Annuity distributions.

You can take distributions penalty free if they are made as part of an annuity, even if you have not turned 59 1/2. The payments must be distributed in equal annual amounts, based on your life expectancy.

The annuity calculation must be based on an IRS-approved distribution method and requires distributions to be made annually.

3. Distributions under divorce or similar proceedings.

Distributions under a divorce or similar proceeding are also exempt from the 10% penalty. This is where there is an imbalance between the spouses’ respective retirement plans, and the court orders a distribution that will result in an equitable allocation of funds between the parties.

Distribution however must be rolled over into another IRA, and must have been made pursuant to a qualified domestic relations order. The order is typically a judgment, divorce decree, or property settlement agreement. Since the proceeds are rolled over into another retirement account, there is also no income tax levied on the distribution either.

4. Death of the plan owner.

If you, as the plan owner, die before turning 59 ½, your heirs will not be required to pay the 10% penalty tax on the distribution of your retirement plan proceeds.

5. Permanent disability.

The IRS defines permanent disability as the inability to “do any substantial gainful activity because of your physical or mental condition.” This claim must be backed by a physician who must indicate that your condition will either be of undetermined duration, or will ultimately result in death.

6. Un-reimbursed medical costs.

You can withdraw funds from your retirement plan penalty-free in order to cover the cost of un-reimbursed medical expenses to the degree that they exceed 7.5% of your adjusted gross income. That is to say that you will be able to make withdrawals penalty free up to the amount that you declare as deductible medical expenses on Schedule A of your individual income tax return.

The medical floor deduction percentage is set to increase to 10% for 2013 and subsequent years.

7. First time home buyers.

You can take withdrawals of up to $10,000 from your retirement plan penalty free for the purpose of buying a first time home under the following conditions (per the IRS):

1. It must be used to pay qualified acquisition costs before the close of the 120th day after the day you received it.
2. It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer who is any of the following:
   *Yourself.
   *Your spouse.
   *Your or your spouse’s child.
   *Your or your spouse’s grandchild.
   *Your or your spouse’s parent or other ancestor.
3. When added to all your prior qualified first-time homebuyer distributions, if any, total qualifying distributions cannot be more than $10,000.

8. College costs.

According to the IRS, you can withdraw funds from a retirement plan penalty-free as long as:

“Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance. In addition, if the individual is at least a half-time student, room and board are qualified higher education expenses.”

9. Unemployed medical insurance premiums

You are exempt from the penalty if you use the proceeds to purchase medical insurance in any year in which you are unemployed. This includes medical insurance purchased for you, your spouse, and your dependents. You are exempt if all of the following apply:

• You lost your job.
• You received unemployment compensation paid under any federal or state law for 12 consecutive weeks because you lost your job.
• You receive the distributions during either the year you received the unemployment compensation or the following year.
• You receive the distributions no later than 60 days after you have been re-employed.

Have you ever withdrawn money from an IRA account for any of the above purposes? Leave a comment!

(Source: IRS Publication 590 )