Taxes on Early IRA Withdrawals
If you withdraw funds early from an IRA, typically there will be taxes to pay on them; however there may be ways around the penalty tax, depending on what your withdrawal is for.
Individual retirement accounts and workplace plans such as 401(k)s usually incur a 10% early withdrawal penalty tax if money is withdrawn prior to reaching age 59 1/2, although there are exceptions that can make withdrawal easier for savers.
1. Withdrawals for Medical Expenses
When withdrawing funds from your retirement account before age 59 1/2, typically, there is a 10% penalty assessed by the IRS. However, they offer certain exemptions for certain circumstances.
Medical expenses that exceed 10% of your AGI qualify for penalty-free withdrawal, without needing to itemize them separately.
Use your IRA funds for qualified educational expenses, such as tuition fees and textbook purchases for you, your spouse, children or grandchildren.
Avoiding an early distribution penalty of 10% by taking a hardship withdrawal for up to $10,000 towards purchasing your first home, you can bypass this fee if you can demonstrate permanent and total disability. To qualify, proof must be presented that would demonstrate this fact.
2. Withdrawals for Disability
As long as you’re neither self-employed or serving in the military, it’s often wise to refrain from tapping your retirement account before age 59 1/2; otherwise you will incur a 10% penalty fee.
But there are exceptions: withdrawals can be made without incurring penalties if certain hardship conditions apply, such as paying higher education expenses for yourself, your spouse or children and meeting qualifying medical costs.
As part of your first home purchase plan, you may also withdraw funds from your IRA without incurring penalties to make a down payment on it. To qualify, several criteria must be fulfilled. Your trusted tax professional can assist in determining eligibility and filling out forms as required. You may even be able to use this strategy to cover IRS levies without penalty!
3. Withdrawals for Unemployment
When withdrawing money from an individual retirement account or employer-provided plan prior to reaching age 59 1/2, generally speaking you will be taxed at your regular income rates plus a 10% penalty. There may be certain circumstances under which this will not apply and distributions could occur without incurring tax or penalty costs.
One exception is if you are recently unemployed worker; according to IRS regulations, up to $10,000 of an IRA withdrawal can be done penalty-free in order to cover expenses associated with job loss.
Consider speaking to a financial advisor prior to using your IRA savings for this purpose – SmartAsset’s free advisor matching tool can help connect you with local professionals if necessary – before accessing it as an emergency source of cash. Here are a few strategies for accessing an IRA while mitigating tax liabilities:
4. Withdrawals for the Birth or Adoption of a Child
Withdrawals made before age 59 1/2 from an individual retirement account are usually subject to income taxes with a 10% penalty tax unless certain exceptions apply; however, The Secure Act adds new exemptions which allow penalty-free distributions:
Starting in 2024, victims of domestic abuse can withdraw up to $10,000 penalty-free within one year of an incident, while first-time home buyers can use up to $10k from their IRA or rollover IRA account towards making down payments without incurring penalties.
Slott emphasizes the need to be mindful in choosing when to withdraw money from an IRA to qualify for this exception. In order to avoid penalties for unreimbursed medical expenses, withdraws should occur during the same year they were paid out-of-pocket.
5. Withdrawals for Rollovers
When taxpayers under age 59 1/2 withdraw funds from a traditional IRA, Simplified Employee Pension (SEP) IRA or Savings Incentive Match Plan for Employees (SIMPLE) IRA, they typically must pay regular income tax plus a 10% penalty. However, there may be exceptions where taxpayers can avoid paying this charge.
New parents can withdraw up to $5,000 tax-free for child birth or adoption expenses without incurring a penalty, while unemployed taxpayers may do the same with health insurance premiums.
Many retirees opt for an automatic withdrawal plan from their IRA over an agreed upon period, to minimize any chance of missing their 60-day rollover window and incurring taxes and penalties; but this approach can erode investment growth.