By: Clay Wyatt
During tough times, you may be tempted to tap into your IRA for much needed money. However, you may face a 10 percent IRA penalty if you do not do so carefully. The IRS only permits you to withdraw funds prior to age 59 ½ without an IRA penalty under limited circumstances. Knowing whether your situation qualifies for an exemption from an IRA penalty will help you avoid additional financial hassles. Let's explore how to get some of that money without paying an IRA penalty (see exceptions to early distributions).
Obviously, the IRS isn't going to exempt you from an IRA penalty if you are looking to purchase a new boat or would like to buy a few thousand lottery tickets. An IRA penalty can typically only be avoided if you have some sort of hardship or for educational, housing, or medical expenses. The following is a list of ways you can use your IRA funds early without incurring an IRA penalty:
- Become permanently disabled: It's probably not a good idea to do this intentionally. However, if this unfortunate situation occurs, you can tap into your IRA to help alleviate the ensuing problems.
- Die: Again, you probably won't want to do this intentionally, but if you die, your beneficiaries will be exempt from paying an IRA penalty to withdraw money, regardless of their ages.
- Go to college: If you need money for higher education costs, you can tap into your IRA for them without paying an IRA penalty. Your spouse, children, and grandchildren are also covered in this regard.
- Lose your job and get medical insurance: Again, it's not the best idea to lose your job on purpose. However, if this happens, you can pay your medical insurance premiums with IRA funds without paying an IRA penalty.
- Become seriously ill: If this occurs, you may not feel great for a while. However, you can soften the financial blow with money from your IRA if your medical expenses exceed 7.5 percent of your adjusted gross income.
- Buy a house: This may actually be a good idea in many situations, unlike most of the other options. You may take up to $10,000 out of your IRA to buy a home without incurring an IRA penalty.
- Get Uncle Sam out of your life: The tax man is always there on pay day, but he can really become a third wheel if you owe him money. If the IRS has placed a levy on your IRA, you may pay it penalty-free with IRA funds.
- Turn age 59 ½: Barring a bizarre reverse fountain of youth, you will not be able to control this one. However, when you do hit this age, you are free to take money out of your IRA. Uncle Sam will still take a cut, but it will be through taxes, not an additional 10 percent penalty.
Whew! You've determined that you qualify for an exemption and will use IRA funds to help get you out of a bind. Not so fast - there is one more hurdle. If the funds are in a Roth IRA, the funds you use must have been in your IRA for at least 5 years (this 5 year rule for qualified distributions differs when applied to contributions vs amounts rolled over). This is in addition to meeting at least one of the listed exemptions. Also, this 5 year requirement is in tax years, not calendar years, so be sure to check with your financial professional or IRA custodian for details if you think it may be a close call. Also, if you have any questions or uncertainties about taking money out of your IRA, it is a good idea to speak with a retirement professional before you do so. Doing so will help you make the right decision and minimize current problems and problems during your retirement years that paying an IRA penalty may cause.
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