How Can I Avoid Paying Taxes on an Early IRA Withdrawal?
In general, taking money out of an IRA before reaching age 59 1/2 will incur an early withdrawal penalty and taxes of 10%; however, there are exceptions that could help you bypass these fees.
Consultations with a financial advisor or CPA is an invaluable way to reduce tax liabilities when withdrawing IRA funds.
1. Don’t Irrevocably Withdraw
IRA withdrawals made before age 59 1/2 usually incur income taxes and a 10% penalty, unless there is an exception. If you need to withdraw money from your IRA for a major purchase that will require withdrawing it early, think carefully about delaying it until next year in order to save on higher tax bills.
Medical expenses and first-time homebuyers may qualify for penalty-free withdrawals from an IRA, though there may be certain restrictions – including a $10,000 lifetime cap and requirements that funds be used exclusively towards purchasing, building or rebuilding their house.
Reservists called into active service may also avoid penalties when withdrawing early from an IRA; however, this exemption doesn’t apply when the IRS levies directly against your account rather than via your IRA itself. Before making any decisions or withdrawals from an IRA account, consult an accountant about this and other available exemptions for withdrawals from an IRA account.
2. Consider Other Income Sources
Removing money early from retirement accounts incurs a 10% tax penalty, so if you need cash quickly it would be prudent to consult a tax professional prior to withdrawing large sums from traditional IRAs and other retirement accounts.
Unemployed individuals receiving unemployment benefits may be eligible to access their IRA funds without incurring penalties in order to cover unreimbursed medical expenses which exceed 7.5% of their adjusted gross income. This exception does not require itemizing your taxes.
First-time homebuyers are eligible to withdraw up to $10,000 penalty-free from their IRA for use towards purchasing or building their first home, either for themselves, their spouse or children within two years before incurring a 10% penalty fee.
3. Build an Emergency Fund
Some may find it necessary or beneficial to withdraw funds early from their retirement accounts; however, to minimize any penalties attached, it would be prudent to build up an emergency fund first and tap your IRA before doing so.
Avoiding penalties by withdrawing for qualifying expenses such as buying your first home, unreimbursed medical expenses exceeding 7.5% of income or paying college tuition and room and board costs for yourself, spouse and/or children. Permanent disability also qualifies for penalty-free withdrawals.
Utilizing this exemption requires adhering to a complex formula based on your life expectancy or that of you and your beneficiary, with any mistakes costing thousands. But getting it right could prove extremely rewarding, says Slott.
4. Roll Over the Money
Though there’s usually a 10% penalty when withdrawing funds before age 59 1/2 from an IRA, in certain situations you might be exempt. For example, using your money from such an account to cover unreimbursed medical expenses or home purchases won’t incur an extra tax burden; similarly unreimbursed expenses incurred during periods of unemployment will not incur penalties.
Avoiding penalties by rolling funds from one IRA into another can also help. This can be accomplished via trustee-to-trustee transfer or direct rollover; just ensure that any reinvestments occur within 60 days for this strategy to qualify.
Finally, consulting a financial professional is always worthwhile to explore your options and avoid penalties altogether. They may offer more long-term strategies that you haven’t thought about yourself and may even help reduce or waive them altogether.
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