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- The IRS allows penalty-free early withdrawals from traditional IRAs in certain circumstances, called hardship provisions.
- Hardship provisions spare you the 10% penalty, but not taxes, on the withdrawn sum.
- IRA early withdrawals that can be penalty-free include expenses for healthcare, college, childbirth, and a first home.
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If you withdraw money from your traditional Individual Retirement Account (IRA) before age 59½, you’ll likely face a penalty. After all, IRAs were designed as a tax-advantaged way to encourage individuals to save for retirement. One way to persuade people to keep the funds intact is by making it painful to withdraw them before they reach retirement – or at least, retirement age.
Following that reasoning, the IRS imposes a 10% penalty (plus income tax in most cases) on early withdrawals, as it dubs funds taken out by those under 59½.
However, there are exceptions. The IRS names certain hardship provisions that allow you to take your money out of your IRA early without paying the 10% penalty. You must meet specific circumstances to make these “hardship withdrawals.”
Here are nine ways to take traditional IRA early withdrawals without paying a penalty.
1. Unreimbursed medical expenses
Meeting medical expenses that exceed 7.5% of your adjusted gross income and are not covered by insurance count as a hardship withdrawal, and so skip the penalty. You must pay for these expenses the same year that you take the distribution but you do not have to itemize your taxes to take advantage of the penalty exception.
2. Health insurance premiums
If you are unemployed, you may be able to pay for health insurance for yourself, your spouse, or dependents using IRA funds. To qualify you'll need to:
- Receive unemployment compensation for 12 consecutive weeks
- Take the distribution either the year you received unemployment or the year after
- Receive the withdrawal before you have been re-employed for 60 days
3. College expenses
You can use penalty-free IRA withdrawals to pay for qualified college expenses for you, your spouse, or your child.
What does qualified mean? It includes tuition, fees, books, supplies, and equipment required for enrollment, and some special needs services. Room and board counts too, as long as the student is enrolled at least half-time.
The school must be an institution that is eligible to participate in government student aid programs to qualify, which includes almost all accredited colleges, universities, and vocational schools.
4. Disability
If you become disabled you may withdraw from your IRA at any time for any reason without paying the 10% penalty. Under IRS rules you are considered disabled if you "can't do any substantial gainful activity because of your physical or mental condition." You will likely need to show proof of your disability from a physician to your IRA administrator for these withdrawals.
5. Home purchase or renovation
You get a pass on the 10% penalty if you withdraw up to $10,000 to purchase, build, or renovate a home. Trick is, you have to be a first-time homebuyer.
But the IRS is generous on that definition. "First-time" just means you haven't owned or built a principal residence in the previous two years. What's more, you can use the funds to help out children, grandchildren or parents, provided they fall within the first-time homebuyer rule.
Your spouse can kick in another $10,000 from their IRA as well as long as they fit the first-time homebuyer definition too. Keep in mind, however, the $10,000 is a lifetime limit for each of you for the home-buying exception.
Even the IRS understands that real estate transactions often suffer delays. If your closing gets postponed, be sure to redeposit the funds within 120 days of the distribution to avoid the penalty. Then re-withdraw it when the time comes.
6. Birth or adoption of a child
This is a new exception, dating from 2020. A parent may withdraw up to $5,000 without penalty within one year of the birth or adoption of a child. A couple may take a total of $10,000 if they are withdrawing from two separate accounts.
Bonus: Parents can opt to redeposit the withdrawals without worrying about annual contribution limits. In other words, they can repay and still make a full contribution to their IRA ($6,000 in 2021, or $7,000 if over age 50) in the same year.
7. Military reserves
If you're in the reserves and you've been called to active duty for more than 179 days, you may take a distribution during your time of active duty and avoid the penalty.
Bonus: Reservists are allowed to pay back borrowed funds within two years of your active duty and still make full annual contributions to their IRAs.
8. Inherited IRAs
Beneficiaries who inherit a traditional IRA may take penalty-free withdrawals before age 59½. In fact, they're required to: The SECURE Act says these beneficiaries have to empty an IRA inherited after Jan.1, 2020, within a decade of the original owner's death. This only applies to non-spousal beneficiaries - children, other relatives, friends. Husbands and wives who inherit the IRA and opt for a "spousal transfer" of the funds into their own IRA would be subject to the early withdrawal penalty (if they're under 59½).
9. Special payments
The IRS allows penalty-free withdrawals before age 59½ for Special Equal Periodic Payments (SEPP). Under these plans, you may take a regular annual distribution for five years or until you reach 59½, whichever comes later.
So if you begin the payments at age 58, they would end when you are 63. If you begin distributions at age 45, you would continue to receive them each year for 14 years until you hit 59½. Ending the arrangement early results in you paying the 10% penalty for all of the money withdrawn.
The amount of the yearly distributions must be determined by one of three IRS approved methods and can be complicated to calculate. You'll likely need the help of a financial or tax professional.
Tips for early IRA withdrawals
Keep in mind these important points when considering an early IRA withdrawal.
You'll likely owe taxes. These hardship provisions get you off the hook for the 10% tax penalty, but not for taxes themselves. In almost all cases you will owe federal and state income taxes on the money. Bear that in mind when figuring how much to withdraw: You may need to adjust the amount to accommodate the tax bill, too.
Read the rules. You'll need to pay special attention to the rules associated with each scenario. If you withdraw more than the maximum allowed, for instance, or fail to provide sufficient proof of your situation or take the withdrawal before or after the time specified, you may incur the 10% penalty.
You'll be sacrificing retirement savings. "The big disadvantage to withdrawing early from any retirement account is the fact that money is no longer invested for retirement," says Steve Vernon, author of "Don't Go Broke in Retirement." Not only do you deplete your savings but you also lose the earnings potential on that money, which can be significant over the long run, he adds.
Consider other sources first. It always makes sense to consider other sources of funds before irrevocably withdrawing IRA money. Taking a loan from your employer-sponsored 401(k) if you have one, might be one good option. With 401(k) loans, you can borrow funds from your account - at a low interest rate, which you pay to yourself - then pay them back, usually within five years. This helps replenish your savings and limits the amount of time you're losing earnings growth.
The financial takeaway
Early IRA (and other retirement account) withdrawals "give you access to your money when your back is against the wall," says Vernon. Indeed, the hardship scenarios - suffering a disability, the need for health insurance, paying medical bills, affording tuition bills, buying a home, the loss of income involved in serving in the military reserves - are certainly times when you need access to your money most. Barring other options, penalty-free withdrawals can be a godsend.
Just be sure to understand and follow the rules carefully so you don't end up paying the penalty anyway. And always remember to plan and budget for the income tax bill you will likely encounter.