What Can You Withdraw From an IRA Without Penalty?
When withdrawing money from an IRA before turning 59 1/2, it is typically taxed as ordinary income and subject to a 10% penalty tax rate. But there may be exceptions.
As an example, you may withdraw funds from an IRA without incurring penalties to cover qualified medical expenses that exceed 10% of your adjusted gross income. Other exceptions may include buying your first home or paying health insurance premiums while unemployed.
1. Withdrawals for medical expenses
The IRS allows you to withdraw funds from an IRA without incurring penalties if they’re used for medical expenses, including annual checkups, prescription medications and treatments that diagnose, prevent or treat an illness or disease. Unfortunately, this doesn’t include elective procedures like cosmetic surgery.
An IRA distribution may also be taken without penalty in order to cover qualifying tuition expenses, which include tuition fees, books and equipment necessary for enrollment in higher education institutions, according to CFP professional Thomas Codevilla of SK&S Law Group in Denver.
CFP professional Joe Gordon of Gordon Asset Management in Durham, North Carolina reports that first-time home purchases qualify for penalty-free withdrawal from an IRA, according to this exception. While it doesn’t apply to employer-sponsored retirement accounts such as 401(k)s and 403(b), traditional and Roth IRAs apply. It also doesn’t apply to SEP IRAs which cater specifically for self-employed individuals and small businesses. When considering your purchase costs and taxes.
2. Withdrawals for unemployment compensation
The IRS assesses an early withdrawal penalty on amounts distributed prior to age 59 1/2, but there are exceptions. One is when distributions are made to pay health insurance premiums while unemployed – for which you need to show evidence of “total and permanent disability”. One simple way is submitting receipts from both your health insurer and Social Security.
An additional exception allows you to withdraw penalty-free funds from an IRA in order to pay for the birth or adoption of a child, including legal fees, agency costs and expenses associated with that event, according to Pederson.
Gordon notes that withdrawing money from an IRA without penalty can also help when purchasing your first home, although you must wait 120 days from withdrawing to complete this purchase – otherwise a 10% penalty applies. IRA funds can also be used to cover an IRS levy bill or pay an outstanding bill from creditors.
3. Withdrawals for college expenses
The IRS permits penalty-free withdrawals from an IRA to pay tuition and fees for undergraduate or graduate courses, room and board at eligible educational institutions, books, supplies and equipment that is specifically used for education as well as any technology used for that purpose such as computers or software.
Distributions made prior to age 59.5 from both traditional IRAs and Roth IRAs may be subject to income taxes and an early withdrawal penalty of 10%; unless one qualifies for an exception. These could include unreimbursed medical expenses that exceed 7.5% of adjusted gross income as well as premiums paid when unemployed for health coverage for yourself, your spouse and/or children.
Disabled individuals may withdraw funds from their IRA tax-free as long as the disability is expected to be permanent and severe, although supporting documentation (usually from your physician) must be provided in order to satisfy IRS requirements.
4. Withdrawals for first-time home purchases
IRA owners can take distributions without penalty from their accounts to help purchase, build or rebuild a primary residence. While the rules can be somewhat ambiguous, first-time homebuyers may use funds for “qualified acquisition costs,” including purchase price but also any “usual or reasonable settlement, financing, closing or similar expenses” plus property taxes according to IRS. There’s a $10,000 lifetime withdrawal exception; money must be used within 120 days.
Removing funds early from a retirement account can often lead to significant compounding losses, and should therefore be avoided at all costs. But if necessary, knowing all available options so as to make informed decisions is critical if need arises. Please note this article provides general advice only and should not be seen as replacing professional advice from CPAs, attorneys, financial planners, or investment managers in their specific capacities.
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