Life is known for throwing curveballs our way—and sometimes they are costly. If you’re years away from retirement but in need of quick cash, you may be tempted to take it from your IRA. But the IRS will take a 10% early distribution tax if you try to tap into your IRA before the age of 59 and 1/2. They’ll also tax it as income—a double blow to your finances. There are some circumstances, however, where you may be able to borrow from your IRA without penalties. Let’s go over eleven ways you can avoid the penalties for early withdrawal.

What is the IRA Early Withdrawal Penalty?

Withdrawals taken before you turn 59 ½ are subject to a penalty of 10%—this is on top of any income taxes you owe based on the withdrawal amount, as IRA withdrawals are considered taxable income. The amount you’ll pay in taxes will depend on your income and which tax bracket you’re in.

There are some exceptions to this rule, however. For instance, some qualifying educational expenses can be paid for using your IRA funds, as can up to $10,000 for the purchase of a new home.

Any withdrawals from your traditional IRA—not your Roth IRA—are subject to income tax. Even if you decide to pursue a withdrawal that qualifies as a special exception, you will pay tax on the withdrawal and the income could push you into a higher overall tax bracket.

Depending on the reason for the withdrawal, the IRS may require specific documentation to corroborate your withdrawal purpose—in the case of using the funds for a home purchase, you’ll need to file IRS Form 5329.

Navigating IRA Early Withdrawal: Penalty Avoidance Strategies

Withdrawal rules surrounding IRA accounts are strict, but there are some special loopholes that help those who need to make hardship withdrawals. Read on to learn eleven ways to get around the 10% early withdrawal penalty.

Delay IRA Withdrawals until 59 and ½

The easiest way to avoid any penalties on withdrawing money from your traditional IRA is to wait until you’re 59 and ½. You’ll still owe income tax based on your income level, but you won’t pay an additional 10% penalty. The only way to prevent paying income tax is to wait longer to make any withdrawals—that said, required minimum distributions kick in at age 72 (73 if you reach 72 after December 31, 2022).

Utilize the Roth IRA Conversion Ladder Method

You are allowed to withdraw from a Roth IRA at any time without taxes or penalties—which is one reason to convert your IRA into a Roth IRA. There are some caveats to note, however: first, because Roth IRA withdrawals are tax-free, you will owe taxes on any amount you move into a Roth.

Second, there’s a five-year waiting period for each conversion. If you withdraw the converted amount before the waiting period is over, you’ll get hit with the 10% penalty. Using the Roth IRA conversion ladder you can withdraw the money without paying the penalty—let’s take a look at how that would work.

To avoid the 10% penalty, plan several Roth IRA conversions spread over multiple years. For example, if you aim to retire at 50, initiate a conversion at age 45 for an amount sufficient for one year's living expenses. This conversion will be ready for withdrawal at age 50, after the completion of the five-year waiting period. Repeat this process in subsequent years, ensuring a specific withdrawal amount when you turn 51 and continuing until age 54. The final conversion at age 54 will allow penalty-free withdrawals once you reach 59 ½, having satisfied the waiting period. This strategic approach provides a pathway to accessing funds from your Roth IRA without incurring penalties.

Apply the 72(t) Rule for Scheduled Distributions

You can arrange to take out “substantially equal periodic payments” (SEPP’s) based on your life expectancy. These are also called 72(t) payments because that’s the section of the tax code you can find it under.

You have to take the same amount of money for five years or until you turn 59 ½, whichever comes later. You can’t stop in the middle, or the IRS will collect the penalty on all of the money, plus interest. The amount of the payments is calculated by the IRS, and you must withdraw the funds based on a specific schedule.

This may seem like a good idea if you need extra cash, but keep in mind that money will no longer be waiting for you when you retire.

Educational Expenses

You can use your IRA money to pay for qualifying educational expenses for yourself, your spouse, you or your spouse’s child, adopted child, foster child or grandchild. Qualifying educational expenses includes: tuition, administrative fees charged by the school, books, and expenses related to disability services, if necessary. Additionally, if the student is in school more than half-time, room and board is another qualifying expense.

The amount you withdraw cannot exceed the specific amount of the qualifying expenses, and you will need to supply proof of enrollment to an accredited university to the IRS. Note that because the withdrawal is taxed as income, you could get pushed into a higher tax bracket which might affect your financial aid eligibility.

First Home Purchase

If you are a first time homebuyer, you are allowed to withdraw up to $10,000 from your IRA to cover your down payment or home building costs without penalty. If your spouse also has an IRA, he/she can withdraw $10,000 for the same home purchase. You can use this money to help a child or grandchild purchase a home as well. However, the $10,000 is a lifetime limit. You have up to 120 days to use the funds after the withdrawal, and income taxes will apply.

Medical Insurance Premiums During Unemployment

If you’ve lost your job and been unemployed for 12 weeks or more, you can take an IRA hardship withdrawal to pay for your health insurance premiums. To maintain clean bookkeeping, plan to have the withdrawal payment sent directly to the insurance carrier, or set up a separate bank account to use for these payments.

Medical Expenses Exceeding a Certain Threshold

Your IRA can be used to pay for qualified medical expenses, but the only amount eligible is the cost difference between your medical bill and 7.5% of your adjusted gross income (AGI). Your AGI is your taxable income minus deductions you claim (such as student loan interest). You also need to take the withdrawal the same calendar year that you received your medical bill.

What counts as a qualified medical expense? Luckily, the definition is very broad, and the IRS allows withdrawals to cover many common checkups, prescriptions, surgeries.

Disability Exceptions

If you or your spouse become disabled and can no longer work, you can take a disbursement from your IRA without a 10% penalty. The IRS will want to see proof from a doctor that you are permanently and totally disabled, which they define as:

Someone who can’t engage in any substantial gainful activity because of a physical or mental condition AND:

A qualified doctor determines that this condition can be expected to last for at least a year or can be expected to result in death.

If you can work in any way (minimum wage or higher), even if it’s not what you spent your career doing, you probably can’t take the disbursement.

One example: Mary used to be a salesperson in a retail store. She retired on disability because she can’t stand for eight hours straight anymore. However, she now works as a full-time babysitter for a neighbor. She is not eligible to utilize her IRA money penalty-free because she is engaged in a gainful activity.

Beneficiary or Estate Withdrawals After Death

If your spouse dies and leaves you their IRA, you can either add the money to your own IRA or you can leave it where it is, and name yourself the new account owner. In addition, you could opt to name yourself as the account beneficiary.

If you’re younger than 59 and ½ you’ll be subject to all of the same rules about withdrawing the money: first-time home buyer, medical expenses, etc.

If you inherit an IRA from someone who is not your spouse, you can’t transfer the money into your own retirement account. You have to open a new IRA and transfer the money to this new account, naming it following very specific rules. The new account must conform to tax law, and read: "[Owner’s name], deceased [date of death], IRA FBO [your name], Beneficiary" (FBO means "for the benefit of"). If the account is simply opened in your name, the balance will be treated as a distribution and you will owe taxes on it.

If the original IRA owner died on or before December 31, 2019 and died before reaching age 70 ½, you can start taking the required minimum distributions no later than December 31 of the year following the death. You can then take distributions without penalty by December 31 of the 5th year following the death.

If the original IRA owner died after reaching age 70 ½, you will need to take the required minimum distributions by December 31 of the year following the year of the death.

If the original IRA owner died on or after January 1, 2020, you are required to distribute the entire balance of the account by December 31 of the 10th year following the original IRA owner’s death. This is a relatively new rule that came out of the SECURE Act—previously, you were allowed to take distributions over the course of your life expectancy.

Birth or Adoption of a Child

After the birth or adoption of a child, you are allowed to receive a distribution of up to $5,000 during the 12-month period following the birth or adoption. Note that you cannot take the distribution leading up to the birth or the adoption—the withdrawal must occur after.

Military Service Exceptions

If you are a qualified reservist, you are not subject to the 10% penalty on early IRA distributions. To meet the IRS’s definition of a qualified reservist, you must meet the following criteria:

• 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) or similar arrangement.
• The distribution was made no earlier than the date of the order to active duty and no later than the close of the active duty period.

Planning and Consulting for IRA Management

Because there are so many nuances when it comes to investing, hiring an advisor to manage and oversee your IRA could be a wise decision. A trusted financial advisor, with expertise in retirement savings accounts, can help you make smart investments, decide whether or not an early withdrawal is a good idea, and assist you when you’re navigating rocky waters—sometimes, all it takes is a better budget and detailed view of your spending.

In addition, your advisor should be able to help you determine whether a traditional IRA—versus a Roth IRA—is the best plan for you. If you expect to be in a higher income bracket during retirement, a Roth IRA might be the better choice. Get matched with a Certified Financial Planner® from Retirable and explore your options.

Withdraw from an inherited IRA

If your spouse dies and leaves you their IRA, you can either add the money to your own IRA or you can leave it where it is. If you’re younger than 59 and ½ you’ll be subject to all of the same rules about withdrawing the money: first-time home buyer, medical expenses, etc.

If you inherit an IRA from someone who is not your spouse, you can’t transfer the money into your own retirement account. You have to open a new IRA in your own name and transfer the money to this new account. You can’t make contributions to this account and you must start taking distributions the year after the owner dies.

You have three choices as to how to take the distributions.

• Lump sum payment
• Following the passage of the SECURE Act in 2019, non-spousal inherited IRAs must be fully distributed within ten years of the account owner's death

You need to make sure you take the required minimum distribution, because otherwise the IRS will incur a 50% penalty on the money that wasn’t withdrawn on time.

Bottom Line

All of the laws regarding retirement accounts and what you can and can’t do with the money can be very complex. If you guess wrong, you’ll be subject to hefty penalties and taxes. Before you consider withdrawing money from an IRA, talk to a Certified Financial Planner® from Retirable. They can help you wade through the ever-changing rules and exceptions on IRAs and make the best financial choice for you.

Frequently Asked Questions

What is the IRA early withdrawal penalty?

The IRA early withdrawal penalty is a 10% fee applied to distributions taken from your Traditional or Roth IRA before the age of 59½, in addition to the regular income tax you may owe on the withdrawal.

How do these strategies impact taxes on IRA withdrawals?

Even with a special exception, any money taken out of a traditional IRA will be subject to income taxes. It is crucial to consider such withdrawals as a last resort. This is not only due to the potential reduction in the amount saved for retirement, limiting the opportunity for compound interest to grow, but also the risk of being pushed into a higher tax bracket during the process. Careful consideration and exploration of alternative financial avenues are advisable before resorting to tapping into your IRA.

Are there age limits for these penalty-free withdrawals?

Generally speaking, no—the exceptions are meant for those under age 59 ½. Once you reach age 59 ½, you won’t be subject to a 10% penalty, only income tax. In addition, note that once you reach age 72 or 73 (depending on when you were born), you will be required to take minimum distributions.

What are some of the exceptions for avoiding the penalty?

• Medical expenses: Amounts exceeding 7.5% of your adjusted gross income (AGI) for medical expenses not reimbursed by insurance can be withdrawn penalty-free.
• First-time home purchase: Up to $10,000 can be used penalty-free towards the purchase of a first home for yourself, a spouse, children, or grandchildren.
• Higher education expenses: Withdrawals can be made penalty-free to pay for tuition, fees, books, supplies, and equipment required for enrollment or attendance at an accredited post-secondary educational institution.
• Disability: If you become disabled before age 59½, you can withdraw IRA funds without penalty.
• Substantially equal periodic payments (SEPP): Setting up a SEPP plan allows you to take regular, equal payments based on your life expectancy.
• Unemployment: If you've been unemployed for 12 consecutive weeks, you can withdraw funds penalty-free to pay for health insurance premiums.
• Birth or adoption of a child: Each parent can withdraw up to $5,000 penalty-free within one year of a child's birth or the finalization of an adoption.

How does the Roth IRA five-year rule affect withdrawals?

For Roth IRAs, in addition to being at least 59½ years old, your account must have been open for at least five years to make tax-free and penalty-free withdrawals of earnings. Contributions can be withdrawn at any time, tax and penalty-free.

Can I withdraw contributions from my Roth IRA without penalty?

Yes, you can withdraw your contributions (not earnings) from your Roth IRA at any time without taxes or penalties, as these contributions were made with after-tax dollars.

What is a Substantially Equal Periodic Payment (SEPP) plan?

A SEPP plan allows you to take early withdrawals from your IRA without penalty by committing to take consistent and periodic payments for five years or until you reach age 59½, whichever comes later. There are specific IRS-approved methods for calculating these payments.

How do I report a penalty-free withdrawal to the IRS?

When filing your taxes, you must report your early IRA withdrawal and claim your exception to the penalty on IRS Form 5329. It's advisable to consult with a tax professional to ensure proper reporting and compliance with IRS rules.

Can these methods be combined for greater financial flexibility?

The answer to this depends on your overall financial picture, age, and more. It’s best to talk to a Certified Financial Planner® about your expenses, investments, and budget. They can take a holistic approach and see which avenues might make the most sense for you to achieve your goals.

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