AVOIDING PENALTIES ON IRA WITHDRAWALS BEFORE AGE 59 ½

IRA owners can withdraw money from their account at any time and for any reason because the owner is in total control of this account. Most withdrawals from traditional IRAs will be at least partially taxable.  To add insult to injury the taxable portion of a withdrawal made before age 59 ½ referred to as an “early withdrawal,” will be subject to a 10% penalty tax. (This penalty can be as high as 25% on early withdrawals from a SIMPLE IRA.)  Finally, there can even be a 10% penalty assessed on a nontaxable portion of some early withdrawals from Roth IRAs.

The 10% penalty tax was implemented to encourage long-term saving for retirement, which is clearly a sound financial objective.  But, sometimes financial circumstances make it necessary to withdraw retirement-oriented savings before age 59 1/2.  If you must make an early withdrawal, there are some ways to avoid the penalty tax.  Early withdrawals from IRAs, including traditional IRAs, SEP accounts, SIMPLE IRAs, and Roth IRAs, can be exempt from the premature withdrawal penalty tax in the following cases:

  • Withdrawals that count as substantially equal periodic payments (SEPPs) using an IRS-approved method.
  • Withdrawals for medical expenses in excess of specific AGI levels.
  • Withdrawals by Military reservists called to active duty.
  • Withdrawals for IRS levies.
  • Withdrawals paid to a deceased plan participant’s estate or beneficiary after death.
  • Withdrawals after becoming physically or mentally disabled.
  • Withdrawals for first-time home purchases ($10,000 lifetime limit).
  • Withdrawals for qualified higher education expenses.
  • Withdrawals to pay health insurance premiums during unemployment.

Unlike early withdrawals from a qualified plan {e.g., 401(k)}, the penalty exception allowing early withdrawals paid to the plan participant’s spouse or ex-spouse or dependent under a Qualified Domestic Relations Order (QDRO) pursuant to divorce proceedings is not available for early IRA distributions.

Caution: If a taxpayer chooses to take SEPPs, these payments must be calculated correctly using an IRS-approved method and taken for the requisite number of years.  Otherwise, all pre-age-59 ½ withdrawals will be hit with the 10% penalty tax!

In a time of economic need, an IRA can be a source of liquidity even before age 59 ½.  If the need is short-term, an IRA withdawal and redeposit of the same amount withing 60 days can be tax-free.  If the need is long-term and before age 59 1/2,  the withdrawal may be fully or partially taxable, but one of the previously listed exceptions may be used to avoid the 10% early withdrawal penalty.

Please contact us to discuss IRA withdrawals before age 59 ½ or any other tax compliance or planning issue.