If you have funds sitting in a traditional IRA, it can be tempting to tap into them – especially if you find yourself facing a financial emergency. While this might seem like the obvious solution to your problem, you will certainly have to pay tax on the early IRA withdrawal, and could also face a 10% penalty. You can make IRA early withdrawals and not have to pay tax if the funds are required for certain expenses that the government has excluded from this rule. The kind of situations where this might apply are listed below:
1. Disability. Early IRA withdrawals without any penalties may be possible if you are no longer able to work due to some kind of mental or physical disability. You will need to provide various documents to take advantage of this exemption, and should seek the advice of an IRA specialist. Different IRA custodians will have different requirements, but you are likely to need some form medical report that suggests the disability is permanent, or is likely to last for the foreseeable future.
2. Higher Education Expenses. If you've decided to go back to school, or if you'd like to assist with the educational expenses of your spouse, children or grandchildren, you may be able to receive tax-free early IRA withdrawals to help cover higher education expenses. Generally, the tax-exempt early IRA withdrawal can be used to pay for books, supplies, and tuition fees from a recognized education establishment. Your IRA custodian can help you to determine whether or not your higher education expenses qualify for this treatment.
3. First-Time Home Purchases. When you're looking to buy or build your first home, the government has made it possible to make an early IRA withdrawal of up to $10,000 without any penalties, to help towards the costs of setting up your first home. As the credit extends to your first home only, the $10,000 cut-off is a lifetime maximum, although this early IRA withdrawal may also be used for a child or grandchild's first home purchase as well.
4. Un-Reimbursed Medical Expenses. If you need to pay un-reimbursed medical expenses, you may be entitled to an IRA early withdrawal if you don't have any medical insurance, or are currently out of work. However, be aware that many restrictions apply to these IRA withdrawals that may limit the amount of expenses you can claim or when you claim them. If you think you might qualify for this type of tax-free early IRA withdrawal, it's best to consult with a tax planner who can clarify how much you're able to distribute from your account.
Although these early IRA withdrawal tax exemptions are intended to help citizens who are facing unexpected financial burdens, there may be some hoops you'll need to jump through before claiming them. To illustrate the point, you are limited to how much you can cover when it comes to un-reimbursed medical expenses, depending on your adjusted gross income. Before making any early IRA withdrawal from your accounts, it's best to consult a tax professional to ensure you aren't setting yourself up for an unnecessary tax burden.
Lose a Fortune on Your 401k Rollover
If you do not do any of these correctly:
- Opt for a distribution rather than direct transfer
- Rollover company stock to an IRA
- Choose to rollover to a Roth IRA
- Rollover to your new employer’s 401k
- Rollover post-tax contributions