What Are the Rules for Cashing in an IRA?

Idealistically, money saved in an IRA should remain invested and grow at a rate exceeding inflation. But what happens if something unexpected arises that necessitates withdrawing it early?

The Internal Revenue Service has rules regarding cashing in an IRA and can take action if any violations occur. Here are some of the regulations:

1. You can withdraw your money at any time

Most retirement accounts come with a 10% early withdrawal penalty on top of income taxes that you owe; however, in certain instances that penalty can be waived–for instance if you’re purchasing your first home or incurring out-of-pocket medical costs.

Rules regarding IRA withdrawals can be complex. Generally speaking, you must begin taking required minimum distributions (RMDs) beginning at age 70 1/2 and pay ordinary income tax on them.

If you don’t take RMDs on time, the IRS imposes a 50% penalty on any missed amounts. Working with a financial advisor to create a strategy to take RMDs without incurring penalties could help avoid them; or you could open and fund a J.P. Morgan Self-Directed Investing account using qualifying new money instead.

2. You can withdraw your money penalty-free

Under certain conditions, the IRS allows you to withdraw money from your IRA without penalty; however, this doesn’t give you free rein to empty out your retirement savings whenever it suits. Taxes and penalties still must be paid upon withdrawal.

For instance, you may withdraw money from a traditional IRA without incurring the 10% early withdrawal penalty if it’s being used to cover unreimbursed medical expenses exceeding 7.5% of adjusted gross income and new parents can take out up to $5,000 from one for their child’s health insurance premiums.

At your required minimum distribution (RMD) age–usually when you turn 73–it is time to take annual distributions from your IRA. Failure to do so may incur hefty penalties; luckily, this can be avoided by rolling over your RMD into another tax-deferred account within 60 days.

3. You can withdraw your money tax-free if you’re a qualified reservist

As a measure to prevent you from raiding your retirement accounts too early, Uncle Sam taxes any funds withdrawn before age 59 1/2 as income tax must also be paid on them.

There are exceptions, however. You may make penalty-free withdrawals of up to $10,000 from either your IRA (or that of your spouse if married) if it’s used to purchase your first home.

Your money may also be withdrawn without penalty if it’s necessary for qualified higher education expenses (tuition, fees, books, supplies and equipment). A Thrivent financial advisor can help devise an optimal withdrawal strategy tailored to your situation; rules may change from year to year so be sure to discuss with them before taking any actions.

4. You can withdraw your money penalty-free if you’re a qualified disability beneficiary

Prior to 2020, an IRA look-through rule allowed you to use distributions from an IRA as payment for unreimbursed medical expenses that exceeded 7.5% of adjusted gross income. Unfortunately, this exception no longer applies for distributions payable via conduit trusts.

Withdrawals from your IRA without incurring penalties can help cover the expenses related to purchasing, building or rebuilding a first home as well as “reasonable settlement, financing and closing costs.” To take advantage of this exception – and use it within two years after purchasing – use it within two years after making the purchase (this applies for you, your spouse and children). Taking substantially equal periodic payments as penalty-free withdrawal options (based on an amortization of account balance over single or joint life expectancies as determined by IRS) can also cover these expenses.

5. You can withdraw your money penalty-free if you’re a qualified first-time homebuyer

As tempting as it may be to withdraw funds early from an IRA in order to fund a down payment on a house, it’s wise to carefully consider its long-term financial ramifications before doing so. Early withdrawal could cost more in taxes and penalties over time than waiting until retirement age would.

Alternately, you can withdraw up to $10,000 penalty-free from your IRA to pay for your first home, provided its closing occurs within 120 days after withdrawing it. Income taxes will still apply on this distribution but without incurring the 10% penalty fee.

This exemption also applies to people purchasing their home with help from family. Just ensure that whoever receives funds qualifies as a qualified first-time homebuyer.