Do you have an IRA? If so, it can be tempting to withdraw from these funds early, especially when you’re worried about your financial security. But, it’s important to be cautious when doing so. If you’re considering early withdrawal from your IRA, here are a few things you should know.
Your Individual Retirement Account (IRA) is a savings account where you keep stocks, bonds, mutual funds, and other assets. There are several types of IRAs: Traditional IRA, Rollover IRA, Simple IRA, SEP-IRA, and Roth IRA. When you opened your IRA, you received great tax benefits and invested in your future: a secure, enjoyable retirement. While you will ideally wait until you’re at least 59 ½ years old to withdraw from your IRA, there may be situations where you need to withdraw early. That said, a penalty may apply.
If you withdraw early from your IRA before you’re 59 ½, you may have to pay a 10 percent tax penalty. Congress put this penalty in place to encourage individuals to save their investment capital for the future, rather than spending it on short-term problems. The good news is that there are exceptions to this rule if you must make an early withdrawal from your IRA.
That 10 percent tax penalty sounds scary, but it doesn’t have to be. You might even avoid that fee for early withdrawal from your IRA if you’re:
1. Buying a Home for the First Time
If you’re a qualified, first-time homebuyer, that 10 percent tax penalty is waived on up to $10,000 of IRA withdrawals. You can use these funds to buy, build, or remodel a first home for yourself, your spouse, a child or grandchild, or a parent or grandparent. You can see if you meet the IRS definition of a first-time home buyer here.
2. Covering Higher Education Costs
If you’re paying for yourself, your spouse, your kids, or your grandchildren to receive higher education, that money doesn’t grow on trees. But, it has been growing in your retirement account, and an early withdrawal from your IRA will not be penalized if you’re doing so to fund schooling. You can thank the Higher Education Act of 1965 for this exception that allows IRA distributions to cover certain expenses for colleges, universities, and vocational schools.
3. Suddenly and Permanently Disabled
If you become permanently disabled—either physically or mentally—and are no longer capable of working to support yourself, you may make a penalty-free early withdrawal from your IRA. Your doctor must certify that you’re no longer able to work and that your disability will either last a significant amount of time or eventually lead to your death. And, if you do unfortunately pass away before age 59 ½, your beneficiaries can inherit your retirement funds without penalty.
4. Inheriting IRA Assets
If you’re the beneficiary of a parent, grandparent, or other non-spouse who has passed away, you won’t have to pay the tax penalty for early withdrawal from your benefactor’s IRA. There are a few more technicalities when it comes to inheriting an IRA from your deceased spouse. If you treat your inherited IRA as your own, then any amount you withdraw will be subject to the tax penalty. However, if you title this as an “Inherited IRA,” then you will have to pay the 10 percent tax penalty.
5. Going into Active Duty
If you are a military reserve who is called to active duty, you will not be subject to the tax penalty for early withdrawal from your IRA. In this case, your withdrawal is a “qualified reservist distribution” when you meet the following requirements:
- You were called to active duty before September 11, 2001;
- You were called to active duty for a period longer than 179 days, or for an indefinite period of time; and
- The distribution was made after the date you were called to active duty and before the period of active duty ended.
6. Paying Your Medical Insurance Premium
If you lose your job or suddenly must pay your own medical insurance premiums, you can make an early withdrawal from your IRA without paying the tax penalty. Keep in mind that this exception only applies if you’ve been on unemployment for more than 12 weeks. Also, if you become re-employed, you cannot receive your withdrawal more than 60 days after your new employment begins.
7. Paying for Steep Medical Expenses
If you or your children are seriously ill or injured, those medical costs can add up quickly. If they exceed 10 percent of your adjusted gross income, you can make an early withdrawal from your IRA without paying the tax penalty. If you qualify for this exception, make sure that you pay your medical expenses the same calendar year that you are withdrawing those IRA funds.
These exceptions can be confusing, and they might differ depending on which type of IRA you have. That’s why it’s smart to consult with a qualified financial advisor who has your best interests in mind. This will help you understand the ins and outs of early withdrawal from your IRA, giving you peace of mind and security about your financial decisions.
Lorenz Financial Services, LLC is a Lafayette, Indiana fiduciary who offers financial planning and portfolio management services. If you have questions about who we are or our services, please contact us at (765) 532-3295 or email us.