IRA Withdrawal Exceptions

By Jon Scott

Abstract: This article highlights withdrawal exceptions allowed by the IRS. Specifically, situations where you can withdraw money from your IRA without early withdrawal penalties.

You’ve probably heard the rule that you cannot withdraw from your IRA without penalty until you reach age 59 ½–well that’s only partially true. In fact, there are many different reasons you may have to withdraw from your IRA without the additional 10% tax.

The 10% Tax Penalty for Early Withdrawals

Withdrawing from your IRA early without a qualified exception will incur a 10% penalty–however, additional taxes and penalties depend on whether the account is a Traditional or Roth IRA.

Qualified Withdrawals

  • Health Insurance Premiums

    • You are able to withdraw from your IRA tax-free to cover health insurance premiums provided the following qualifications are met:

      • You are unemployed and are receiving federal and/or state unemployment compensation for at least 12 weeks

      • You withdrew in the year or the year after you received unemployment

      • You withdrew within 60 days since being re-employed

  • Permanent Disability

    • If you are permanently disabled and can no longer work, the IRS allows you to withdraw penalty-free. The money can be used for any purpose; however, you will want to show your plan administrator proof of permanent disability before completing the withdrawal

  • Higher Education Costs

    • Many expenses related to higher education for yourself, spouse, or child are tax-exempt. These include tuition, fees, books, room and board, and supplies for students enrolled at least half-time. The rules here are a little gray, so it is best to check with a tax professional before withdrawing

  • Inheriting an IRA

    • Inheriting an IRA is tax-exempt if it originates from a non-spouse, though the amount inherited must be included in your adjusted gross income (AGI)

  • First-Time Home Purchase

    • You are able to withdraw $10,000 to buy, build, or rebuild a first home for a parent, grandparent, yourself, or spouse. However, you must meet the first-time homebuyer qualifications set by the IRS

    • If buying with a spouse, you can withdraw up to $10,000 each without penalty

    • The funds must be used to pay for qualified purchase and closing costs 120 days after receiving the money

  • Adopt a Child

    • Legal adoptions qualify for an exemption as long as the withdrawal comes within the first year after the date of adoption. The withdrawal is capped at $5,000

  • Reservists called to Active Duty

    • Reservists called to active duty after September 11, 2001 are granted an exception provided that:

      • The call to active duty was for a period of more than 179 days

      • The withdrawal was taken from an IRA or from funds attributable to elective deferrals from a 401k or 403b or a similar account

      • The distribution was made after being activated to active duty and no later than the close of active-duty period

Withdrawals from Traditional IRA Vs. Roth IRA

Unqualified withdrawals before age 59 ½ incur heavy penalties, including a tax at the income level for that tax year as well as a 10% penalty. For example, a $10,000 withdrawal will incur a 10% penalty, bringing that withdrawal down to a total usable amount of $9,000, plus a hit at your current income. Someone making over $41,775 but not over $89,075 will be taxed at 22%, bringing the total usable amount of the withdrawal down to $6,800.

Traditional IRA withdrawals exemptions will still face an income tax since a traditional IRA is a pre-tax account. Income taxes are also applied to qualified withdrawals after age 59 ½.

Roth IRA Withdrawal Penalties

Since Roth Contributions are made with after-tax dollars, nonqualified withdrawals from a Roth IRA are not double-taxed like a Traditional IRA, meaning that Roth IRA contributions incur a 10% tax. In fact, you can withdraw your initial contributions without penalty; however this is generally not a good idea.

Qualified Roth withdrawals can be made tax without any tax penalty for any circumstance after age 59 ½ as long as the Roth IRA has been active for at least five years.

Substantially Equal Periodic Payment (SEPP)

SEPP plans distribute funds from an IRA or other qualified retirement plan before age 59 ½ while also avoiding IRS withdrawal penalties. Funds are withdrawn penalty free via annual distributions for a period of five years or when the account-holder turns 59 ½–whichever comes later.

The withdrawals are still subject to interest payments. For example, you can begin an SEPP plan in your 30s, but you will need to stick with it until you turn 59 ½ . Starting a SEPP is best served toward the end of your working career if you will need the money before turning 59 ½. Like other IRAs, nonqualified withdrawals are subject to a 10% penalty.

Best Practices

The best choice regarding withdrawals will depend on your economic situation. However, for most individuals, couples, or families it is best to avoid any withdrawal that is subject to a 10% penalty. There are very few situations short of an absolute emergency or urgent liquidity need to subject oneself to the taxes and penalties for unqualified withdrawals.

However, qualified withdrawals may be a good method to pay for school, home, or medical related expenses. Therefore, it can be important to keep in mind that money contributed to an IRA is not only available in retirement, and so contributing the maximum amount each year can be advantageous for other purposes as well.