Despite good intentions to keep money stashed away in your IRA, life happens. So, you may need some of that cash before your retirement to address any number of financial crises. Unfortunately, an early IRA withdrawal before age 59 1/2 can trigger a 10 percent tax penalty in addition to the requirement to include that cash in your gross income at tax time. There are, however, early withdrawal exceptions.
What Is the Early Withdrawal Penalty?
You reap the tax breaks and employer contributions that an IRA grants you only if you sidestep the plan penalties that the Internal Revenue Code imposes. These penalties may be triggered if you withdraw cash from the account either too early or too late.
Read More: How Much Tax Will I Owe on an Early Withdrawal?
How Is an Early IRA Withdrawal Taxed?
A distribution from your traditional IRA, regardless of the reason for it, is included in your taxable income in the year of the distribution. Also an early withdrawal from an IRA – a withdrawal of funds before the account owner is 59 1/2 – results in a 10 percent penalty on the funds withdrawn. For instance, if you withdraw $10,000 early, the 10 percent penalty will be $1,000.
Read More: How to Reverse an IRA Distribution
Early Withdrawal Penalty Exceptions
There are several instances in which that penalty may be waived. For instance, the early withdrawal penalty doesn't apply if the owner of the IRA account is younger than age 59 1/2 and the distributions occur after the individual becomes disabled. Other exceptions include the following events:
- Distribution that's rolled into another retirement plan: An IRA account holder has 60 days from the day she receives an IRA distribution to roll it over to another IRA.
- Distribution initiated by the death or permanent disability of the IRA account owner: If you become disabled before you reach age 59 1/2, and that disability leads to a distribution from your IRA, the distribution is not subject to the 10 percent penalty.
- Distribution upon the separation of employment of an account owner who is 55 years of age of older: If you've been let go by the sponsor of your IRA plan, and that plan issues a check to you, if you roll it over into a new IRA within 60 days of receiving the funds, that event is not a withdrawal that's subject to taxes and penalties.
- Distribution to a spouse by a court order in a divorce: Transferring the assets in an IRA to a former spouse penalty-free requires a divorce decree and your adherance to the benefit provisions and administrative rules that govern the transfer.
- Distribution in the amount of deductible medical expenses: Regardless of age, you aren't penalized if you take a distribution in the amount of an unreimbursed medical expense minus 7.5 percent of your adjusted gross income if the medical treatment occurred in the year of the distribution.
- Distribution in the amount of unreimbursed medical expenses in excess of 7.5 percent of the account holder's AGI if the account holder is 65 or older or 10 percent if under age of 65: If you don't have health insurance or have a high-deductible health plan, and you have major out-of-pocket medical expenses, the IRS may allow a penalty-free distribution to pay the out-of-pocket expenses. To avoid the 10 percent early withdrawal penalty, you must withdraw the cash in the year that you pay the medical expenses, and the expenses must be greater than 10 percent of your 2021 adjusted gross income (AGI.)
- Distribution due to IRS levy: A distribution that's made directly to the U.S. government to satisfy an IRS levy will not trigger a 10 percent early withdrawal penalty.
- Distributions made as substantially equal periodic payments over the expected lifetime of the IRA account owner: If your IRA distributions consist of a series of substantially equal periodic payments over your life expectancy or those of you and your designated beneficiary, the 10 percent penalty doesn't apply.
- Distributions for payment of insurance premiums for an unemployed account owner: When your IRA distributions are due to your need to pay insurance premiums during a period of unemployment, the IRS won't impose the 10 percent penalty.
- Distribution for home buyer expenses up to $10,000 for the first-time home buyer: You won't incur a 10 percent penalty if the purpose of your IRA withdrawal is to buy, build or rebuild a home and you are a first-time home buyer.
- Distribution for education expenses: The cash in your IRA can fund the tuition or other qualified higher education expenses for your own education or that of your spouse, children or grandchildren without penalty.
- Distribution for expenses – up to $5,000 – arising from the birth or adoption of an account holder's child: In 2019, Congress passed the SECURE Act, which allows a parent to withdraw as much as $5,000 from an IRA following the birth of their child without incurring a 10 percent early withdrawal penalty.
- Distribution after 09/01/01 due to the call-up of reservists to active duty: Assuming that you are a qualified reservist – National Guard member or military reservist – your IRA distributions may not be subject to the 10 percent penalty.
- Internal Revenue Service: Topic No 557 Additional Tax on Early Distributions From Traditional and Roth IRAs
- Internal Revenue Service: What if I Withdraw Money From My IRA?
- ICON: Lost My Job. What Do I Do With My Retirement Account?
- Internal Revenue Service: Retirement Topics – Exceptions to Tax on Early Distributions
Billie Nordmeyer is an IT consultant of 25 years standing. As a senior technical consultant for SAP America and Deloitte Touche DRT Systems, a business analyst, senior staff, and independent consultant, Billie has worked across the retail, oil and gas, pharmaceutical, aeronautics and banking industries. Billie holds a BSBA accounting, MBA finance, MA international management as well as the Business Analyst and Software Project Management certificates from the Cockrell School of Engineering at the University of Texas at Austin.