When Can You Withdraw Money From Your IRA Without Incurring the 10% Penalty?
Though accessing retirement accounts early can be tempting, financial experts advise against it as this will rob your future self of years of compound growth. There may be situations in which withdrawals from an IRA account can be made without incurring a 10% penalty fee.
Withdrawals made before age 59 1/2 will typically incur income taxes plus an additional 10% penalty, unless one of the exceptions applies.
1. You’re a first-time homebuyer
First-time homebuyers may qualify for special rules allowing them to withdraw money from their IRA without incurring the 10% penalty, provided certain requirements are met.
Traditional, rollover, SEP and SIMPLE IRAs allow individuals, business owners, self-employed people and some employers to make pretax contributions that will remain tax deferred until withdrawal at retirement time.
Withdrawals from an IRA may incur income taxes and the 10% penalty unless used to help pay for qualified first-time homebuyer expenses or medical/disability hardship. You can use funds from an IRA to pay higher education expenses such as tuition fees, books and room and board; however these must be reported on your tax return.
2. You’re a first-time homebuyer with a hardship
IRS rules allow first-time homebuyers to withdraw up to $10,000 without incurring a penalty from their IRA without incurring a lifetime maximum penalty, which may help cover down payment costs on their new home. However, any penalty-free withdrawal will require paying income taxes and forfeiting potential growth that money would have provided over time.
Unemployed individuals needing health insurance premiums or expenses related to disability can draw upon their retirement savings without incurring income taxes; this exception does avoid the 10% early withdrawal penalty; however, at age 59 1/2 you must adhere to required minimum distribution (RMD) rules which are calculated using life expectancy as determined by the IRS.
3. You’re buying a second home
The IRS allows you to withdraw up to $10,000 penalty free from an IRA to cover qualified acquisition costs when purchasing, building or renovating a new home, as well as typical and reasonable settlement, financing and closing expenses.
Your IRA funds may also be accessed penalty-free for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income (AGI), unemployment compensation during 12 consecutive weeks and permanent disability or funeral costs associated with deceased family members.
A second home purchase can be an excellent financial decision, provided it fits in with your goals and finances. Before making this commitment, however, it’s wise to carefully assess both aspects of this purchase decision.
4. You’re buying a second home with a hardship
The IRS allows IRA owners to withdraw funds without penalty if the money is used to cover certain expenses, including unreimbursed medical costs that exceed 10% of their adjusted gross income, higher education costs for you, your spouse, children or grandchildren and first-time homebuyer costs.
For these purposes, the withdrawal limit for home purchase or construction contracts is $10,000 per person per lifetime limit that begins when they sign a binding contract to purchase or build one. You may withdraw multiple amounts to cover various qualifying expenses within that lifetime limit; however, no total withdrawal exceeds $10,000.
Note, however, that any money withdrawn from an IRA will become part of your income and subject to taxation. Prior to withdrawing money, consult a financial planner and tax professional so they can evaluate both short- and long-term implications of making such withdrawals.
5. You’re buying a second home with a hardship
There are various circumstances under which it is permissible to withdraw funds from an IRA without incurring the 10% penalty, in order to assist with purchasing a home. You will still owe regular income taxes on this withdrawal, however.
Assuming you’re a first-time homeowner and haven’t owned another property within two years, a penalty-free distribution could cover the expenses associated with purchasing your first home. The maximum withdrawal limit cannot exceed $10k though.
Your funds can also be withdrawn penalty-free to cover qualifying higher education expenses for you, your spouse and children, as well as health insurance premiums for yourself, your spouse and dependents. To maintain an audit trail and leave no traces, payments should be sent directly to the insurer.