Rules for Optional and Mandatory IRA Withdrawals

Optional IRA Withdrawals

If you have an IRA, you can make a withdrawal from it at any time. However sometimes the withdrawal is quite detrimental because of the IRA penalty and other times there is no problem. Let's look at several different times that you can take IRA withdrawals and the ramifications of each.

This 60 day rule. You may withdrawal any or all of your IRA for a period of 60 days, once per year. As long as you return the funds to the IRA within that 60-day period, there are no penalties or taxes. Therefore, your IRA can be used as a short term personal loan.

Withdrawals prior to age 59 1/2. Generally, if you make IRA withdrawals prior to age 59 1/2 and do not return the funds within 60 days, you will not only over the income tax which you have never paid on those funds but also a 10% penalty. There are however a number of exemptions to this IRA withdrawal penalty. Note that even though the 10% penalty may be wived, you still owe the income tax on IRA withdrawals. Let's look at a few of the more common penalty exemptions here.

1. Disability

If you become permanently disabled, you can make unlimited IRA withdrawals without penalty

2. Death

This exemption won't do you any good, but your heirs, regardless of age, can get your IRA funds without penalty.

3. Non-reimbursed medical expenses or medical premiums

If your medical expenses that you need to pay (i.e. not covered by insurance) exceed 7.5% of your adjusted gross income (the number at the bottom of the first page of your tax return), you can make an IRA withdrawal without penalty for the the amount that exceeds 7.5% of your AGI.

Closely related is the penalty free allowance to use your IRA account to pay medical premiums if you have been on unemployment for longer than twelve weeks.

4. Home purchase

Although $10,000 won't go very far in some parts of the US to buy a home, you can withdraw $10,000 to help buy a home if you have not owned a home in the prior two years. If married, your spouse must also have not owned a home in the previous 2 years.

5. Costs of Higher education

It's time to send junior to college and you're short on cash. IRA withdrawals have a penalty free green light from IRS. Note that the expenses can be for any member of your immediate family, even you!

6. IRS levy

If you owe federal income taxes and IRS has placed a levy on your qualified plan (e.g. 401k), you can use the IRA account to make payments, penalty free.

There are other exemptions from the IRA penalty as well as penalty exemptions on withdrawals from qualified plans.

It is also possible that these exemptions can be used in combination to increase the amount that can qualify as penalty free IRA withdrawals.

Mandatory IRA Withdrawals

Come age 70 1/2, you must start taking IRA withdrawals so that IRS can collect the tax they have permitted you to defer. If you fail to do so, the penalty is a whopping 50% of the amount you failed to withdraw. While there are no exemptions for failure to withdraw from a traditional IRA, there is an exemption for qualified plans: if you are still employed at age 70 1/2 and you don't own more than 5% of the company, you can defer your initial mandatory withdrawal until the year after you retire.