7 Ways That You Can Avoid the IRA Early Withdrawal Penalty of 10%

• Author: Jacob Greene
• Posted: 2024-04-11

If you withdraw money from your IRA prior to the age of 59 1/2, you are likely going to be subject to a 10% early withdrawal penalty. Savvy investors know that there are some exceptions to this rule, depending on how you plan to spend the money. Here are seven instances in which you can avoid paying this significant penalty on your money.

Delay Withdrawals

The easiest way to avoid paying this 10% penalty is to simply wait until you are age 59 1/2 to even think about taking this money from your IRA account. Even if you officially retire prior to this age, you are not eligible to take this money without penalty unless you meet certain purchase exemptions.

Health Expenses

One major exception to avoiding the early withdrawal penalty is if you use the money for healthcare expenses. In most cases, you are not subject to the penalty if you use an IRA distribution to cover the cost of medical costs that are not eligible for reimbursement by standard health insurance. In addition, the costs must exceed 10% of your adjusted gross income in order to qualify for the exemption, making it important that you read the fine print. It is also not necessary to itemize your taxes to use this exception for healthcare costs.

Health Insurance Costs

If you are out of a job and lose your health insurance, you can take an early IRA withdrawal without penalty to put toward insurance premiums. You must be collecting unemployment compensation for 12 straight weeks in order to qualify for the distribution free of penalty. You can use the money to cover health insurance premiums for yourself, your spouse, and any dependents. It is also mandatory to take this distribution during the year that you took the unemployment compensation or over the following year.

First Home Purchase

Looking to buy your first home and struggling to come up with a down payment? You can use up to $10,000 or $20,000 for couples from your IRA without having to pay the penalty if you are using the funds to buy or build a first home. You must not have owned a home for the two years prior in order to qualify for this penalty exemption. You also must put the cash back into the IRA within 120 days if the sale does not go through. The money may be used for a first home for yourself, a child, a parent, or a grandchild.

College Expenses

There is no doubt that the cost of college can be extremely prohibitive for some people looking to advance their education. These IRA distributions are allowed without a penalty if you use them to pay for college tuition, books, fees, and supplies. If the student is a half-time student or greater, you can use the distribution to pay for room and board costs. The money can be used for yourself, a spouse, children, or grandchildren. Keep in mind that these withdrawals are considered taxable income, meaning that they may affect financial aid eligibility.

Physical or Mental Disability

If you find yourself in the position of no longer being able to work because of a physical or mental disability, you may find that you can draw on your IRA with no penalty. You will be required to submit proof that you are not able to work due to your disability. This means you will likely need the documentation to be signed off by a medical professional equipped to determine the extent of your disability and how it impacts your employment prospects. Short-term disabilities are not usually approved for this type of penalty exemption.

Inherited IRA

Individuals who inherit an IRA before they turn 59 1/2 can also take penalty-free withdrawals. However, they will be subject to pay income tax on each distribution. There are also rules governing the differences between IRA inheritances from spouses. A financial professional can help you to work through all of these details so that you know how it applies to your specific situation.

Understanding how and when you can take money from your IRA without having to pay the standard 10% penalty can help you to make more informed financial decisions, saving you a significant amount of money in the long term.