Putting money away in an Individual Retirement Account (IRA) or Qualified Retirement Plan is a great way to plan for your future retirement days. However, planning is much easier than predicting. Some of us might put money away but then realize we need it way before we ever reach that magical retirement age of 59 ½. As far as the IRS is concerned, 59 ½ is the minimum age you must reach before you can begin distributing from your IRA or Qualified Retirement Plan. If you do take distributions before you reach that age, be ready and willing to pay a 10% penalty on that distribution.
Unbeknownst to many people, the IRS does have a compassionate and understanding side to people’s ill fate or financial volatility. If certain circumstances arise, the IRS will allow you to withdraw from your plan before you reach the age of 59 ½ without a 10% penalty on that distribution. Note that the distribution itself will still be subject to your individual tax rate. Below are some instances where distributing savings from your IRA or Qualified Retirement Plan before you reach the minimum age will not generate a 10% penalty.
- Higher Education Expenses – Withdrawals to pay for qualified higher education (net of any scholarships) of the taxpayer, spouse, child, or grandchildren can be taken as long as the expense occurs in that same calendar year as the distribution.
- First-Time Home Purchase – Taxpayers can withdrawal up to $10,000 without penalty for themselves, spouse, children, and grandchildren. However, this is only allowed once per distributor. Payment toward the home must be made within 120 days of distribution.
- Medical Expenses (in excess of your AGI limitation) – Taxpayers can withdrawal up to the amount of medical expenses that are deducted on your Schedule A, Itemized Deductions, after applying the AGI (Adjusted Gross Income) limitation. This limit applies even if you did not itemize. In 2018, a taxpayer must have medical expenses in excess of 7.5% of their AGI before their distributions from an IRA to be considered exempt from penalty. Any distribution in excess of this amount would be subject to the penalty.
- Medical Insurance Premiums – Withdrawals for medical and long-term care insurance, if the taxpayer has received unemployment compensation (or if self-employed, would had qualified for unemployment compensation) for at least 12 consecutive weeks in the year of withdrawal or the previous year. This withdrawal must be done before the taxpayer is reemployed for 60 days. Any withdrawals after this period would be subject to the penalty.
- Death – Distributions of beneficiaries to a decedents IRA will not be subject to the penalty.
- Disability – If the taxpayer were to become disabled, penalty on any distribution would not apply. This disability does not need to be permanent.
- Levy – Involuntary Federal seizure of funds will not be subject to penalty.
- Affected Hurricane Disaster Areas – Victims living in designated hurricane disaster areas (Harvey, Irma, or Maria) may distribute up to $100,000 in relief that would not be subject to penalty.
- Affected California Wildfire Areas – Victims living in designated wildfire disaster areas in California may distribute up to $100,000 in relief that would not be subject to penalty.
- Divorce – Exclusion from the penalty applies to 401(k)s and other select qualified plans, IRAs would not be excluded from the 10% penalty.
Please consult with your tax advisor before distributing from your retirement account to make sure all requirements are met for the specific exemption.