Trusts and Estates

Penalty-free Early IRA Withdrawals

Traditional individual retirement accounts are a good way to save for retirement. When times get tough, however, and you need some extra cash, it can be tempting to withdraw some of this money before the minimum age of 59.5.

This is almost always a bad idea, unless you are up against a wall and have exhausted every other option.

To encourage Americans to save for their retirement years, IRAs offer significant tax benefits. To discourage us from dipping into these accounts before they have time to grow, the government imposes penalties on traditional IRA withdrawals made before age 59.5.

You will pay income tax on the money withdrawn, plus a ten percent early withdrawal penalty.

Exceptions to the Early-Withdrawal Rules

The Internal Revenue Service authorizes certain exceptions to these early-withdrawal rules. You still have to pay income taxes on the money withdrawn, but you can avoid paying the penalty.

Large medical bills - Medical expenses that are not covered by insurance and that are more than 7.5 percent of your adjusted gross income. This includes bills for you, your spouse and your dependents.

Health insurance - Medical insurance for you, your spouse and your dependents if you lose your job and have collected federal or state unemployment compensation for a least 12 consecutive weeks.

College costs - Higher education expenses for you, your spouse, and the children or grandchildren of you or your spouse. Qualifying expenses include tuition, fees, books, supplies and equipment required for attendance. If a student is enrolled at least half-time, room and board costs qualify. (Such distributions count as income, however, and could affect financial aid eligibility.)

First home - Costs to buy, build or rebuild a first home. A “first time” homebuyer is defined as someone who hasn’t owned a home in the past two years, but this exception can be used only one time. For an individual, the amount is $10,000. If both spouses are first-time buyers, the limit is $20,000. Once withdrawn, the money must be spent or returned to the IRA within 120 days.

Early retirement - To provide retirement income prior to age 59.5, money may be withdrawn from your IRA in a series of carefully calculated payments over your life expectancy or the joint life expectancies of you and a beneficiary. This is called the “substantially equal periodic payment” program, or SEPP. You must make the withdrawals for at least five years or until you turn 59.5, whichever comes later. Once you opt into this program, you are locked in. You can’t make any new contributions to the IRA or take additional withdrawals from it.

Total and permanent disability - To qualify for this exception, you need a note from a physician confirming that your disability prevents you from doing any “substantially gainful activity” and that your condition is permanent.

Military service - Members of the military service can take distributions without paying a penalty if they were ordered or called to active duty after Sept. 11, 2001, for a period of more than 179 days or for an indefinite period. The distribution must be taken during the active duty period.

Inheritance - If you are the beneficiary of a deceased holder of an IRA, you need not pay a penalty on the distribution. However, you cannot roll over the IRA into your own name without paying a penalty.

Natural disaster - Occasional legislation allows for IRA distributions for a certain period of time by those affected by natural disasters.

Call an Estate Planning Lawyer

The issues surrounding early withdrawals from traditional IRAs can be complicated. Plus, the facts of each case are unique. This article provides a brief, general introduction to the subject. It is not legal advice. For more detailed, specific information about your situation, contact an estate planning lawyer.

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