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8 Exceptions to the 10% Penalty for an Early IRA Withdrawal

by Jason on August 18, 2010

Need cash?  Thinking about taking an IRA withdrawal?

Think long and hard because you may have to pay  a nice little 10% penalty for early IRA withdrawals!

IRA penalty – Oh yeah, Uncle Sam will love you!

If you are age 59 1/2 or older, you can take an IRA withdrawal without any penalties at all.

If you’re younger than age 59 1/2 you’ll have to pony up for an IRA penalty – unless of course you meet one of the exceptions below.

IRS publication 590 lists these exceptions to the 10% penalty for an early IRA withdrawal:

1. You take an early IRA withdrawal and you have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.

If you have a lot of medical debt, you may be able to take out IRA money without that 10% penalty.  Remember, medical expenses must be higher than 7.5% of your adjusted gross income.

2. You can take an early IRA withdrawal for medical insurance

As long as your IRA distribution is not more than you paid for medical insurance you will not have to pay a 10% penalty if the following applies:

  • You lost your job
  • You received unemployment for 12 consecutive weeks because you lost your job
  • You receive the IRA distributions during the year you received unemployment or the following year
  • You receive distributions no later than 60 days after you’ve been re-employed

3. You can take an early IRA withdrawal if you are disabled.

Bad news – you’re disabled.  Good news – no penalty.  Not sure I’d really want to qualify for this one, but it is there.  Be sure to file a special tax form with your 1040 that lets the IRS know that you are disabled!

By the way – it’s a good idea to check out disability insurance before you become disabled too!

4. If you are the beneficiary of a deceased IRA owner, you can take an IRA withdrawal.

Ok, so Uncle Ritchie leaves you his IRA and you’d like to go buy a new 5 Series – no penalty!

5. Your IRA withdrawal consists of receiving distributions in the form of an annuity.

Basically what the IRS means here is that you must take “substantially equal period payments”  – in other words a set amount per year for either a) five years or b) til 59 1/2, whichever is longer.

6. Your IRA withdrawal is not more than your qualified higher education expenses.

Alright, so you’d like to use your IRA money for college savings!  Great news – your IRA withdrawal (as long as it is not more than your tuition) can be taken penalty free!!

7. Your IRA withdrawal is used to buy, build, or rebuild a first home.

First home.  That’s the key here.  Not your second, third or fourth – it’s your first home and you are buying, building or rebuilding – then you can take an IRA withdrawal penalty free.

Guess what though – a first-time homebuyer is actually defined as a homebuyer who has not lived in a main “purchased” home for the preceding two years.

So, if you owned a home, sold it and rented for over 2 years and then decided to buy again – you’d qualify!!

8. Your IRA withdrawal is a qualified reservist distribution

A qualified reservist distribution is met if:

  • 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, 401k or 403b plan
  • The IRA withdrawal is made no earlier than the date of the order or call to active duty and no later than the close of the active duty period

These exceptions have some qualifiers on them so it’s important to look at the IRS publication to make sure you fit into one of these categories before you take the money out.

Also, don’t fall into the trap thinking that these exceptions are for taxes!  You still have to pay taxes on any withdrawal you take out.  The exception is for the penalty only!

So there you have it, 8 ways to avoid the penalty for your IRA withdrawal!

This post was included in the Tax Carnival #75!

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