The Internal Revenue Service frowns on using the funds in your individual retirement accounts for any purpose other than your retirement. To discourage you, the IRS imposes a penalty of 10 to 25 percent, depending on the type of IRA, on top of the regular income tax you must pay for the money. Recognizing that certain conditions may require you to make changes to your retirement plan, however, the IRS does allow exceptions to the penalties. Although you are not technically borrowing from your IRA, there are ways to tap into it when you incur significant medical expenses without suffering the sting of the penalty tax.
Withdrawals Prior to Filing Tax Return
You may withdraw your contributions for the current or previous year without paying a penalty if you comply with the IRS rules completely. In addition to the principal, you must withdraw the interest that your money earned while it was invested. You must make the withdrawal before the due date for your return, including any extensions. You must not claim a deduction for your contribution; if you have already filed, you must file an amended tax return within six months of the date your return was due, excluding any extensions, to remove the deduction.
Early Distribution From an IRA
Early distributions from a traditional IRA are subject to a 10 percent tax in addition to your normal income tax on the money. However, if you have unreimbursed medical bills that exceed 7.5 percent of your adjusted gross income, you may take an early distribution without incurring the 10 percent penalty tax. The most you can withdraw without penalty is your actual expenses less 7.5 percent of your adjusted gross income, and the distributions will still be taxable income. You can also avoid the penalty tax if you qualify as disabled, regardless of your income.
If you can replace the money within 60 days, you can roll over your IRA and use the money tax-free for those two months. However, the account manager will likely withhold 20 percent to backstop taxes. You must replace all of the money, including the backup withholding, by the due date to avoid penalties and taxes. Your account manager will forward the portion withheld to the IRS, and you can recover it when you file your taxes for the year. You can only roll over an IRA once every 12 months if you are doing it solely to borrow against it. Roth IRAs rolled over in less than five years and SIMPLE IRAs rolled over in less than two years may not qualify as tax-free transfers. A SIMPLE IRA early distribution is subject to a 25 percent penalty tax instead of the 10 percent that is standard for other types of IRAs.
Early Distributions for Medical Insurance Premiums
You can take an early distribution without paying the penalty tax if you are unemployed and withdraw no more than you need to pay the premiums on your medical insurance. To qualify, you must have received unemployment benefits, take the distributions no later than the year following your receipt of unemployment benefits, and receive the funds within 60 days of returning to work. Premiums to cover yourself, your spouse and your dependents are eligible.
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