If you take money out of your traditional IRA before age 59½, it’s considered an early distribution. All early distributions are reported to IRS and may be subject to tax plus an additional 10% tax (a/k/a the “early withdraw penalty”) unless you meet an exception.
One of the most common exceptions is a rollover. That happens when you withdraw money from one plan and redeposit those funds into another qualifying plan. The rules about rollovers, including the time restrictions, are complex; and there are rarely exceptions and fixes if you goof. So pay attention to the rules, especially this one: in most cases, you must complete the rollover within 60 days after the day you received the distribution in order to avoid paying tax on the rollover.
But suppose you need the money and can’t do the rollover. At the very least, you’ll want to avoid paying a penalty in addition to including the money withdrawn in income.
If you make an early distribution, you’ll also avoid the 10% additional tax if any of the following exceptions apply:
- You have unreimbursed medical expenses that are more than 10% of your adjusted gross income (AGI) – yes, this is the same rule for claiming medical expenses on your Schedule A; however, with the Obamacare exception for seniors, if you or your spouse is age 65 or older, the threshold is 7.5%.
- The total of your early distributions is less than the cost of medical insurance you paid for yourself, your spouse, and your dependents during a period of time when you were unemployed for 12 consecutive weeks.
- You are totally and permanently disabled. You’ll need to be able to prove that due to your physical or mental condition, you can’t do any “substantial gainful activity.” This condition can’t be temporary: a doctor must certify that it will result in death (there’s a grim thought!) or that it will be of a “long, continued, and indefinite duration.”
- If you die before reaching age 59½ (not necessarily the way that you want to avoid the extra tax), the assets in your traditional IRA can be distributed to your beneficiary or to your estate without being subject to the 10% additional tax. However, if you inherit a traditional IRA from your spouse and elect to treat it as your own, any distribution you receive before you reach age 59½ is considered an early distribution and may be subject to the 10% additional tax.
- You are receiving early distributions from a traditional IRA in the form of an annuity. This can be substantially equal payments over your life or your life expectancy, or over joint life expectancies. You must use an IRS-approved distribution method, and you must take at least one distribution annually for this exception to apply.
- Your early distributions are less than qualified higher-education expenses paid for you, your spouse, or the children or grandchildren of you or your spouse. Qualified higher-education expenses include tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution; if the student is at least half-time, room and board are also considered qualified higher-education expenses. When figuring your total, there’s no double dipping: you generally can’t include expenses paid with tax-favored accounts like a Coverdell education savings account or other tax-free payments.
- You use the distributions to buy, build, or rebuild a first home for yourself, your spouse, your or your spouse’s child, your or your spouse’s grandchild or your or your spouse’s parent or other ancestor. There is a cap: when added to all your prior qualified first-time homebuyer distributions, if any, total qualifying distributions cannot be more than $10,000.
- The distribution is a qualified reservist distribution. To qualify, you must have been ordered or called to active duty after September 11, 2001, for a period of more than 179 days or for an indefinite period because you are a member of a reserve component. The early distribution must be made from a traditional IRA or certain qualified plans no earlier than the date of the order or call to active duty and no later than the close of the active duty period.
- The distribution is due to an IRS levy (clearly, second only to your own death in terms of how you don’t want to qualify for the exception).
- Use of a QDRO. If a Qualified Domestic Relations Order (QDRO) is drafted as part of a divorce decree with the order to assign or divide and assign a portion of the assets of your 401k plan to or with your former spouse, this withdrawal is penalty-free.
Bear in mind that this is a partial list. For a detailed analysis that fits your situation, use the button below to contact us.
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