Saving money for your retirement in an Individual Retirement Account has several financial and tax benefits. But sometimes you may need money urgently and have no option but to withdraw early from your IRA.
Unfortunately, early IRA withdrawals call for penalty. In order to avoid the penalty on an early withdrawal, you should be aware of the exceptions to the rule. These exceptions usually revolve around the purpose, timing and amount of the withdrawals.
Read on, to find out more how you can avoid a penalty on your IRA withdrawals.
1. Delay the withdrawals
As the rule goes, you’ll have to pay a 10% penalty if you withdraw from the IRA before turning 59 1/2 year old. So, simply put, if you manage to postpone withdrawals till that time, you’ll be spared the penalty. This is the most basic way you can avoid the early withdrawal penalty on your IRA.
2. Withdrawal for military services
The IRA rules recognize exceptions for early withdrawals. Military service men can take advantage of one such exception to the rule. Any member of the military reserve called to duty after September 11, 2001 for a duration of more than 179 days is eligible for the exemption from penalty. One important condition, however is that you should’ve taken the distribution while on active duty.
3. Withdrawal for first home purchase
The IRA rules allow you to withdraw funds for your first home purchase without any penalty. The amount allowed under this rule is limited to USD 10,00 for an individual, and USD 20,000 for couples.
There are some other conditions which must be met. You should not have owned a home for the two years prior to the new home purchase. You can use the withdrawn money to fund not only your own home, but a home for your child or grandchild.
In case the purchase gets cancelled or the construction for your new home gets delayed, you’re required to put the money back into the account to avoid any penalty.
4. Withdrawal for child birth or adoption
New parents are allowed to withdraw money from the IRA without attracting the early withdrawal penalty. You’re allowed to withdraw up to USD 5000 from the IRA within a year of the childbirth or adoption.
5. Withdrawal for medical expenses
Medical and health care expenses also bring you some leverage when it comes to the IRA rules. If you withdraw from the IRA for paying medical bills not covered by your health insurance, you’ll get the advantage. The expenses should be significant enough, at least 7.5% of your adjusted gross income. An IRS professional can help you work out the maximum amount you can withdraw from your IRA account without attracting a penalty.
6. Withdrawal for paying health insurance premium
IRA withdrawals by unemployed individuals for paying health insurance premium do not present for the penalty. To qualify for the unemployed status, an individual should be collecting unemployment compensation for 12 consecutive weeks, and should have withdrawn from the IRA in the same year.
7. Annuity payments
Another way to avoid penalty on early IRA withdrawals is to set up a series of annuity payments, with at least one withdrawal every year. The amount of annuity payment is determined based on your life expectancy or the joint life expectancies of you and your partner. These calculations require assistance of an IRS Attorney.
8. Withdrawal for disability support
If someone is hit by a major disability and becomes unable to work, the IRA rules permit withdrawals without any penalty. However, there is a requirement for supporting documents establishing the person’s inability to get gainful employment for a long or indefinite period. The disabled person’s condition needs to be certified by a physician.
9. Withdrawal for college education
You’re allowed to make IRA withdrawals without penalty to support your college education expenses too. The expenses include tuition fees, books and materials, equipment like computer, laptop and other supplies, as well as boarding or hostel expenses for a college, university or vocational schools. The penalty-free withdrawals can be made for your own education, or for the education of your spouse, children or grandchildren.
10. Roth IRA
Roth IRA comes with much less restrictions than the conventional IRA account. Even the penalty for early withdrawal is significantly less. In order to avoid an early withdrawal penalty, your Roth IRA should be at least 5 years old.
Besides the convenience, there are other advantages of opening a Roth IRA. First, the Roth IRA distributions are not taxable unlike the traditional IRA. Second, you are not compulsorily required to take distributions from your Roth IRA account after the age of 72.
11. Inherited IRA
Your kith and kin might have left behind their IRA for your inheritance. If that’s the case, you’re allowed to make penalty free withdrawals even before the age of 59 1/2 years. As the rule prescribes, you have to withdraw all assets from an inherited IRA within a decade of the owner’s death. But the exemption for early withdrawal penalty is not available if you’ve inherited the IRA from your spouse and choose to use it as your own IRA.