Q. When can I do penalty-free IRA withdrawals if I am under age 59 and half?
A. While early withdrawals are usually tax free, there are situations you can at least avoid the 10% penalty. Here is a list of such situations.
Taxable Part of Withdrawals
First, in most cases, in any withdrawal from a traditional IRA, the taxable percentage depends on whether you’ve made any nondeductible traditional IRA contributions over the years. If you have, each withdrawal consists of a proportionate amount of your total nondeductible contributions (to however many IRAs you own), and that part is tax-free. The proportionate part of each withdrawal that consists of deductible contributions and accumulated earnings (from all your traditional IRAs) is taxable. If you’ve never made any nondeductible contributions, 100% of any traditional IRA withdrawal will be taxable.
Now when you can avoid penalties.
1. Substantially equal periodic payments (SEPPs)
SEPPs are something once you start, you have to keep it going for at least five year or until age 59.5, whichever comes later. There are three different methods for calculating SEPPs, check with your accountant to make sure you are choosing the right method. If you don’t stick with the program, the taxable portion of all pre-age-59 1/2 withdrawals from the annuitized account can be hit with the 10% penalty tax.
2. Withdrawals to Cover Medical Expenses
If you pay medical expenses that exceed 10% of your adjusted gross income (AGI) for the year, you can take penalty-free early IRA withdrawals up to the excess amount. (AGI is the number at the bottom of page 1 of your Form 1040; it includes all your taxable income items and is reduced by certain deductions such as alimony paid to an ex-spouse and moving expenses.)
3. Withdrawals to Cover Higher Education Expenses
Early IRA withdrawals are penalty-free to the extent you pay qualified higher education expenses during the year. The expenses must be for the education of you, your spouse, or a child, stepchild, or adopted child of you or your spouse.
4. Withdrawals to Cover Health Insurance Premiums While Unemployed
This exception is limited to those who receive unemployment compensation for 12 consecutive weeks under any federal or state unemployment compensation law during the current year or the preceding year. Early IRA withdrawals taken during the current year are penalty-free up to the amount paid during the year for health insurance premiums to cover you, your spouse, or your dependents. However, early withdrawals taken after regaining employment for at least 60 days won’t qualify for penalty-free treatment.
5. Withdrawals after Disability
Early IRA withdrawals taken by an account owner who is physically or mentally disabled to the extent that he or she cannot work in his or her usual job or business activity or a similar job or business activity are exempt from the 10% penalty tax. The disability must be expected to be of long or indefinite duration (although it need not be permanent) or lead to death.
6. Withdrawals to Cover First-Time Home Purchase
You can take penalty-free early IRA withdrawals to cover amounts spent within 120 days on qualified home acquisition costs, there is a lifetime limit of $10,000. The home must be a principal residence acquired by you, your spouse, your child, grandchild, or grandparent — or your spouse’s child, grandchild, or grandparent. The buyer (and spouse if applicable) must not have owned a principal residence within the two-year period ending on the home acquisition date.
7. Withdrawals to Satisfy IRS Levies
Early IRA withdrawals taken by the IRS to pay federal tax levies against the IRA itself (as opposed to levies against the account owner) are exempt from the 10% penalty tax.
8. Withdrawals by Military Reservists
Qualified early withdrawals taken by military reserve members called to active duty for at least 180 days or for an indefinite period are exempt from the 10% penalty tax.
9. Withdrawals after Death
Amounts paid to a deceased IRA owner’s estate or account beneficiary after the account owner’s death are exempt from the 10% penalty tax.
Special Note
Oddly enough, some of the penalty-free exceptions for IRAs are not available for early withdrawals from qualified retirement plan accounts, such as 401(k) accounts.
A. While early withdrawals are usually tax free, there are situations you can at least avoid the 10% penalty. Here is a list of such situations.
Taxable Part of Withdrawals
First, in most cases, in any withdrawal from a traditional IRA, the taxable percentage depends on whether you’ve made any nondeductible traditional IRA contributions over the years. If you have, each withdrawal consists of a proportionate amount of your total nondeductible contributions (to however many IRAs you own), and that part is tax-free. The proportionate part of each withdrawal that consists of deductible contributions and accumulated earnings (from all your traditional IRAs) is taxable. If you’ve never made any nondeductible contributions, 100% of any traditional IRA withdrawal will be taxable.
Now when you can avoid penalties.
1. Substantially equal periodic payments (SEPPs)
SEPPs are something once you start, you have to keep it going for at least five year or until age 59.5, whichever comes later. There are three different methods for calculating SEPPs, check with your accountant to make sure you are choosing the right method. If you don’t stick with the program, the taxable portion of all pre-age-59 1/2 withdrawals from the annuitized account can be hit with the 10% penalty tax.
2. Withdrawals to Cover Medical Expenses
If you pay medical expenses that exceed 10% of your adjusted gross income (AGI) for the year, you can take penalty-free early IRA withdrawals up to the excess amount. (AGI is the number at the bottom of page 1 of your Form 1040; it includes all your taxable income items and is reduced by certain deductions such as alimony paid to an ex-spouse and moving expenses.)
3. Withdrawals to Cover Higher Education Expenses
Early IRA withdrawals are penalty-free to the extent you pay qualified higher education expenses during the year. The expenses must be for the education of you, your spouse, or a child, stepchild, or adopted child of you or your spouse.
4. Withdrawals to Cover Health Insurance Premiums While Unemployed
This exception is limited to those who receive unemployment compensation for 12 consecutive weeks under any federal or state unemployment compensation law during the current year or the preceding year. Early IRA withdrawals taken during the current year are penalty-free up to the amount paid during the year for health insurance premiums to cover you, your spouse, or your dependents. However, early withdrawals taken after regaining employment for at least 60 days won’t qualify for penalty-free treatment.
5. Withdrawals after Disability
Early IRA withdrawals taken by an account owner who is physically or mentally disabled to the extent that he or she cannot work in his or her usual job or business activity or a similar job or business activity are exempt from the 10% penalty tax. The disability must be expected to be of long or indefinite duration (although it need not be permanent) or lead to death.
6. Withdrawals to Cover First-Time Home Purchase
You can take penalty-free early IRA withdrawals to cover amounts spent within 120 days on qualified home acquisition costs, there is a lifetime limit of $10,000. The home must be a principal residence acquired by you, your spouse, your child, grandchild, or grandparent — or your spouse’s child, grandchild, or grandparent. The buyer (and spouse if applicable) must not have owned a principal residence within the two-year period ending on the home acquisition date.
7. Withdrawals to Satisfy IRS Levies
Early IRA withdrawals taken by the IRS to pay federal tax levies against the IRA itself (as opposed to levies against the account owner) are exempt from the 10% penalty tax.
8. Withdrawals by Military Reservists
Qualified early withdrawals taken by military reserve members called to active duty for at least 180 days or for an indefinite period are exempt from the 10% penalty tax.
9. Withdrawals after Death
Amounts paid to a deceased IRA owner’s estate or account beneficiary after the account owner’s death are exempt from the 10% penalty tax.
Special Note
Oddly enough, some of the penalty-free exceptions for IRAs are not available for early withdrawals from qualified retirement plan accounts, such as 401(k) accounts.
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