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8 Exceptions to the IRA 10% Early Withdrawal Penalty

How to Avoid the IRA Early Withdrawal Penalty

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If you have a traditional IRA, where all contributions you made were tax-deductible, then any time you take an IRA withdrawal, the full amount withdrawn will be included in your adjusted gross income for the calendar year in which you took the IRA withdrawal. (Rollovers or transfers are not considered an IRA withdrawal.)

An early withdrawal is an IRA withdrawal taken before you reach age 59 ½, which is subject to a 10% penalty tax in addition to ordinary income taxes.

Below are eight situations which may qualify you for an exception to the 10% penalty tax on an IRA early withdrawal. There are no exceptions to paying ordinary income tax on the amount withdrawn.

1. Medical Expenses

You used your IRA early withdrawal to pay medical expenses that are more than 7.5% of your adjusted gross income.

2. Medical Insurance

You are unemployed, you used the IRA early withdrawal to pay for your medical insurance, and you meet the additional requirements below:

  • You received unemployment compensation paid under federal or state law for twelve consecutive weeks because you lost your job.
  • You receive the IRA withdrawal during either the year you received the unemployment compensation, or the following year.
  • If you have since been re-employed you cannot have received your IRA withdrawal more then 60 days after your new employment started.

3. Disability

You took an IRA early withdrawal because of a disability. According to the IRS website,

"You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration."
4. You Inherit An IRA
  • If you inherit an IRA from a non-spouse, even if the IRA owner was under age 59 1/2 , you will not have to pay the penalty tax on amounts withdrawn. You will still have to include any IRA withdrawal in your adjusted gross income.
  • If you inherit an IRA from a spouse, and you choose to treat it as your own IRA, then any IRA early withdrawal you receive will be subject to the 10% penalty tax.
  • If you inherit an IRA from a spouse, but you choose to title the IRA as an "inherited IRA", then you would be eligible to receive IRA early withdrawals without paying the 10% penalty tax.

5. You Receive Your IRA Withdrawal In The Form Of An Annuity According to IRS Guidelines Called 72t Payments

Created by Internal Revenue Code Section 72(t), the Substantially Equal Periodic Payment(SEPP) rule lets account-holders withdraw money from their retirement accounts at any age, penalty free, if they follow certain rules.

There are three IRS approved methods for calculating the amount of your SEPP withdrawal. I cover the details of these calculations in How to Use 72(t) Payments for Early IRA Withdrawals. You must stick with your withdrawal schedule for a minimum of five years, or until you reach age 59 ½ (whichever event occurs later) or all amounts withdrawn may become subject to the penalty tax.

6. Qualified Higher Education Expenses

IRA early withdrawals used to pay qualified higher education expenses on behalf of you, your spouse, or the children or grandchildren of you or your spouse, are exempt from the 10% penalty tax if they were paid to an eligible educational institution.

When determining the amount of the distribution that is not subject to the 10% additional tax, do not include qualified higher education expenses paid with any of the following funds:

7. First Time Home Purchase

Up to $10,000 of an IRA early withdrawal that is used to buy, build, or rebuild a first home for an ancestor (parent or grandparent), yourself, a spouse, or you or your spouse's child, or grandchild, may be exempt from the 10% penalty tax if you meet the IRS definition of a first time home buyer.

If both you and your spouse qualify as first time home buyers then each of you could withdraw $10,000 from each of your respective IRAs without paying the 10% penalty tax.

The distribution must meet all the following requirements:

  • It must be used to pay qualified acquisition costs (which includes reasonable closing costs) before the close of the 120th day after the day you received it.
  • When added to all your prior qualified first-time homebuyer distributions, if any, total qualifying distributions cannot be more then $10,000.

8. Qualified Reservist Distributions

A qualified reservist distribution is not subject to the additional tax on IRA early withdrawals.

According to the IRS a distribution you receive is a qualified reservist distribution if the following requirements are met:
  • You were ordered or called to active duty after September 11, 2001.
  • You were ordered or called to active duty for a period of more than 179 days or for an indefinite period because you are a member of a reserve component.
  • The distribution is from an IRA or from amounts attributable to elective deferrals under a section 401(k) or 403(b) plan or a similar arrangement.
  • The distribution was made no earlier than the date of the order or call to active duty and no later then the close of the active duty period.

The information in this article is taken directly from the online IRS Publication 590, where you can find additional information on IRAs and IRA early withdrawals.

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