If you know much at all about your IRA, you’re probably aware that, generally, you must wait until after age 59½ before withdrawing funds from the account, or you’ll be subject to a 10% penalty in addition to the tax on the distribution. You may also be aware that there are several exceptions to this penalty – one of which is the use of a Series of Substantially Equal Periodic Payments. What we’re going to review in this article are the “other” exceptions; those specific situations that are uniquely identified by the IRS as not subject to the 10% penalty.
Exceptions to the 10% Early Withdrawal Penalty
Below are the specific exceptions that the IRS has identified that allow you to withdraw IRA money without the 10% penalty:
- Qualified Higher Education Expenses – you can withdraw your IRA funds to help pay for college expenses. Qualified Higher Education Expenses (QHEE) (oh my word, is there an acronym for EVERYTHING??) include tuition and related expenses at an eligible educational institution. Related expenses can include student-activity fees (only if paid to the institution) and books, materials and equipment, if purchased from the institution. Expenses that are not considered QHEE include insurance, medical expenses (including student health insurance fees), transportation, and other personal living expenses. Room and board is included as a QHEE if the student is at least a half-time student. Distributions must be taken in the same year that the expenses are paid out, and cannot be the same expenses that have been paid by a Coverdell plan, a 529 plan, a scholarship, grant or any other tax-free assistance.
- Death – If you die, your beneficiaries are able to take distributions from your IRA without penalty. In fact, the beneficiary of an IRA will be required to take distributions from the account – read more about this in the article Stretching Your IRA – A Legacy in the Making.
- Disability – If you are “totally and permanently disabled” by IRS definition, you can take distributions from your IRA without penalty. 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.
- High Unreimbursed Medical Expenses – for yourself, your spouse, or your qualified dependent. If you face these expenses, you are allowed to withdraw a limited amount (the actual expenses minus 7.5% of your AGI) without penalty. Only those expenses that you could otherwise claim as deductions on your Schedule A (Form 1040) above the 7.5% AGI floor are eligible for this exception.
- Medical Insurance Premiums – if you’ve lost your job and receive unemployment compensation, you are eligible to withdraw an amount to pay for your medical insurance premiums, if all of the following conditions also apply:
- You received unemployment compensation paid under any federal or state law for 12 consecutive weeks or more because you lost your job
- You receive distributions from your IRA either during the year you received the unemployment compensation or the following year
- You receive distributions from your IRA no later than 60 days after you have been re-employed
- First-Time Home Purchase – up to $10,000 ($20,000 for a couple) of the costs of buying, building, or re-building a “first home”. First home is determined if you had no present interest in a main home for two years prior to the purchase. If you are married, your spouse must also meet the non-ownership qualification as well. The distribution must be paid toward these costs within 120 days of the date you received the distribution, and the home can be for yourself, your spouse, your child (or your spouse’s child), your grandchild (or your spouse’s grandchild), or any ancestor of yourself or your spouse (meaning parent, grandparent, etc.).
- Qualified Reservist – If you were called to duty after September 11, 2001 and serve for at least 6 months (specifically more than 179 days), you are allowed to make a withdrawal from your IRA during your active duty period without penalty. The withdrawal must occur on or after the date that you are called to active duty. This exception also applies to your elective deferrals in a 401(k) plan, a 403(b) plan, or other similar qualified retirement plan, in addition to an IRA.
- Divorce – although not a particular IRS regulation, multiple Private Letter Rulings have allowed divorced parties to “split” an IRA into two separate IRAs, both with the original restrictions on distribution. It’s important to note that a QDRO (Qualified Domestic Relations Order) does not apply to your IRA. In order for an IRA to be split as a part of a divorce, this must be included as a part of the divorce decree, specifically identifying the account, amount, etc., that is to be split.
- Roth IRA Conversion – when you convert your funds from a Traditional IRA to a Roth IRA, although you pay tax on the distribution, there is no 10% penalty applied.
- Rollover – using the 60-day period, you are eligible to have access to your funds without penalty as long as the rollover is completed within 60 days. The same holds true for a trustee-to-trustee transfer, although this is generally not considered a distribution.
- Payment to Advisor/Investment Manager – you are allowed to authorize your custodian to pay your Advisor or Investment Manager from your IRA funds any fees for managing your IRA. This includes transaction fees and annual custodian fees. If you have an arrangement with an Advisor or Investment manager and you pay for this arrangement via a fee to the Advisor, you can avoid the tax on this amount by paying the Advisor with funds from your IRA – in fact the Advisor in most cases can deduct the fee directly from your account.
- Periodic Temporary “Relief” provisions – from time to time, as the situation merits, Congress will enact special legislation allowing individuals impacted (primarily) by natural disasters to access IRA funds without paying the 10% penalty. One notable example of such a provision recently was for victims of Hurricane Katrina.