In case of an economic tough spot, you might be inclined to use the savings you have accumulated in a conventional IRA. However, premature early IRA withdrawals (withdrawals prior to age 59 1/2) are always a bad idea for two reasons: firstly a 10% IRA penalty on premature withdrawals will be levied on you and secondly, you have to pay the standard IRA income tax for the withdrawal as well.
The government has created a few exceptions to this rule which enable you to make early IRA withdrawals penalty-free.
Here are few of them:
1. Disability. If a person is permanently mentally or physically incapacitated, and is not able to earn a sufficient living, this person is excused from paying fines on early IRA withdrawals. Those people who fall in this category should consult with their IRA custodian so that they will provide them the opportunity to avail of the rule relaxation by informing them about the relevant documents required. Most times, and it varies from one custodian to another, disabled people are asked to bring a note from their physician stating that the disability is permanent. When the custodian issues a 1099 form at year-end, it will be coded for disability thereby informing IRS that the early IRA withdrawal is penalty-free.
2. Costs to be incurred for higher education. The second exception which will exempt your early IRA withdrawal from penalty is when you have to pay for your higher education or that of your spouse, children and grandchildren. However, under this provision, only books, fees, tuition, and other supplies are covered. IRA withdrawals must be used towards a eligible educational institution.
3. Purchasing a home if you have not owned a home during the previous 2 years. For up to a $10,000 early IRA withdrawal, the U.S. government annuls the penalty tax. It must be noted that the $10,000 is a lifetime maximum, and it can be used even for a child or grandchild's home purchase .
4. Un-reimbursed medical expenses. In case you are not gainfully employed or do not hold health insurance, you are eligible for early IRA withdrawals without being charged the penalty. It should be noted that there are certain restrictions, in terms of amount and time that regulates the details of these penalty-free early IRA withdrawals opportunities. If you believe you have a strong case to avail yourself of these early withdrawal opportunities, it is high time to seek advice from a tax planner who can clarify the nuances of the decision and guide you forward. The general rule is that early IRA withdrawals which exceed 7.5% of your adjusted gross income and are used for medical expenses will not be assessed the penalty.
5. Closely related to the above is early IRA withdrawals for people unemployed for 12 weeks or more who use the withdrawn funds to pay premiums for health insurance.
The sole reason behind formulating these alternative rules is to help people in times of financial emergency, but there are roadblocks that you will have to maneuver around. Note that the IRA distribution income tax is due in all cases above.
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