In general, money in your IRA is supposed to stay there until you reach age 59-1/2. The IRS recognizes, however, that unexpected difficulties can make this impossible and therefore allows some exceptions. One of these hardship exceptions is for large medical bills not covered by health insurance. Provided you use IRA money only as a last resort and only for qualified expenses, the IRS won’t levy a penalty tax. You'll still have to pay ordinary income taxes on the money withdrawn for either a traditional or Roth IRA.
Compile a list of your assets. The IRS will not exempt you from the penalty tax for early withdrawal if you have other assets that can reasonably be liquidated to pay unreimbursed medical expenses. You need to provide an accounting of assets to show that you do not have significant savings or investments such as stocks and bonds that you could use instead of your IRA money.
Determine whether some of your medical expenses qualify for payment with IRA funds. To do this, add up all medical expenses not paid by health insurance. Next, use IRS Form 1040 ES to estimate your adjusted gross income for the current year. Multiply your estimated adjusted gross income by 7.5 percent. If the amount of unreimbursed medical expenses exceeds 7.5 percent of your estimated adjusted gross income, you can pay the excess over 7.5 percent with IRA funds without incurring the penalty tax.
Use Form 1040 ES to determine the amount you can actually withdraw from your IRA. The sum you may withdraw is equal to the total amount of unreimbursed medical expenses minus the taxes you must pay on this total. For example, if the qualified medical expenses equal $4,000 and the tax liability on this amount equals $1,000, you can withdraw only $3,000. The amount of tax you must pay has to remain in the IRA until your account trustee or custodian sends it directly to the IRS.
Withdraw the money to pay the unreimbursed medical expenses from your IRA. Explain to your account custodian or trustee what you are doing so he can be sure all the paperwork is completed properly. Also, the trustee/custodian needs to know to remit the money you owe in taxes to the IRS. He'll send you documentation of the withdrawal and tax payment for you to attach to your tax return.
Pay the medical bills immediately or as soon as the money is credited to your checking account. Request receipts for each item from the health care provider.
Complete IRS Form 5329: Additional Taxes on Qualified Plans. This form is used to figure the amount of the withdrawal that is subject to the penalty tax, if any. As long as the amount you withdrew is equal to or less than the amount you are eligible to withdraw, there will be no penalty.
Enter the amount of taxable income from Form 5329 on your tax return. On Form 1040, this goes on line 15a. On 1040A, use line 21. For 1040EZ, enter the amount on line 4. Attach copies of all medical receipts, your withdrawal from the IRA, your list of assets and Form 5329 to your tax return.
Items you will need
- IRS Form 5329
- Documentation of assets
- Documentation of medical expenses
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