What Are Penalty-Free IRA Withdrawals?

Jul 19, 2022 By Susan Kelly

The Internal Revenue Service (IRS) has a penalty of 10% for early IRA withdrawals to motivate you to save your retirement savings. However, you might be able to get around penalties in some situations. Here are some scenarios that allow your early withdrawals from an IRA that is a conventional or Roth IRA without being penalized.

Unreimbursed Medical Expenses

If you do not have health insurance or have out-of-pocket medical costs that aren't covered by insurance, you might be eligible to take penalties-free distributions of your IRA to pay for these expenses. To be eligible, you must pay for medical expenses within the same calendar year that you make the withdrawal. In addition, your medical expenses not reimbursable must be more than 10 percent of your 2021 adjusted gross earnings.

For instance, if your AGI equals $100,000, but your medical expenses amount to $15,000, then the maximum amount you can give away penalty-free is $5,000. This is the gap between the $15,000 figure and 10% of AGI ($10,000).

A Permanent Disability

Suppose you are permanently disabled and cannot work In the event of a permanent disability. In that case, the IRS allows you to withdraw funds from your IRA without paying the penalty of 10. The distribution can be used for any reason. But be aware that the plan administrator might require you to show disability proof prior to signing off on a withdrawal without penalty.

Higher Education Costs

A college education is expensive nowadays. If you're paying tuition and fees, your IRA might be a good source of funds. You can avoid paying the penalty of 10% if you utilize IRA assets to cover certain higher education expenses that are eligible for you, your spouse, or your child. Qualified higher-education expenses include fees, tuition, books, supplies, and other equipment required to enroll. Room and board are also provided for students taking classes at minimum half-time.

Additionally, it is important to note that the IRS has specific rules regarding tax benefits and the method of calculating what is exempt from the penalty of 10%. Consult an expert tax advisor to determine if your expenses meet the requirements. Also, check-in with your school's office to confirm that you meet the criteria to be a part of the curriculum.

You Can Inherit an IRA

When you're the owner of an IRA, the withdrawals you make aren't affected by the 10% penalty for early withdrawals. This exemption doesn't apply when you're married to the account holder who originally opened it or as the only beneficiary, and you decide to do the option of a spouse transfer (by which you transfer the money into your own, non-inherited IRA). In this scenario, the IRA is considered as if you owned it from the beginning. This means that the 10% early withdrawal penalty is still in place.

Your IRA provider must be able to report the amount you take out as a death benefit by adding the number "4" in box 7 in the seventh box of IRS Form 1099-R, which is the form that is used to record the distribution. Consult your IRA custodian or trustee about the documentation you'll require to complete your transaction.

To Purchase, Build or Rebuild a Home

You can withdraw the maximum amount of $10,000 (that's an annual amount) in your IRA without penalty to build, buy or remodel a home. To be eligible, you need to be a "first-time" homeowner--in this instance, you've not had a house in the last two years. But, you may have owned a home before and be able to qualify as a first-time homebuyer in the present. In the event of a marriage, you and your partner can take an additional $30,000 from the IRA. Additionally, you can apply the funds to aid your child, grandchild, or parent, as long as they are first-time homebuyers.

Insubstantially Equal Periodic Payments

If you have to regularly withdraw funds out of an IRA for a couple of years and you are eligible, the IRS permits you to withdraw your funds at no cost if you satisfy certain conditions. You withdraw the same amount, determined by some of these three IRS-approved methods, every calendar year for five years or until you reach the age of 59 1/2 or later. This is called making substantially equal periodic payments (SEPPs) out of your IRA.

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