You must know the early withdrawal penalties if you have an IRA or 401(k). The government imposes a 10% penalty for early withdrawals from IRA and 401(k) accounts until 59 1/2. However, some early distributions are exempt from that penalty — such as in cases of hardship, higher education expenses, or purchasing a first home. This guide will discuss tips and strategies to help you avoid penalties and keep your retirement savings intact!
What is the early withdrawal penalty?
Generally, individuals who withdraw money from retirement plans (401(k) and IRA) before they are at the normal retirement age (59 1/2) pay a 10 percent penalty (in addition to ordinary income taxes) on their withdrawal. With that said, there are exceptions.
Early Withdrawal Taxes
There are instances when it is possible to withdraw from an IRA and 401(k) without penalty.
Taxes Owed When Withdrawing From A 401(k) Or IRA.
Traditional IRA and 401(k) withdrawals are taxed at your ordinary-income rate.
Related Reading: 401k vs. Roth 401k
Roth IRA
Contributions to a Roth IRA may be withdrawn at any time, and earnings will not incur penalties or taxes (if the Roth IRA has existed for five years).
How to avoid early withdrawal penalties from your IRA or 401(k)
- Unpaid Medical Bills
- Permanently Disabled
- Pay for Health Insurance
- You Die
- Unpaid Taxes
- Paying For a Home
- College Expenses
- 72(t) Distributions
- Rule of 55
- Natural Disasters
- Called To Active Duty
Medical bills
You may withdraw money from your qualified retirement plan to pay for unreimbursed deductible medical expenses that exceed 10 percent of your adjusted gross income.
To withdraw money, the medical bills incurred must be the same year.
You do not need to list all your deductions to take advantage of this exception from paying the 10% tax penalty. You can read about it in Publication 590.
Permanently Disabled
The IRS says that if you are totally and permanently disabled, you can take money from your retirement account without paying a 10% penalty.
When you are disabled, the easiest way to prove it is by collecting disability payments from an insurance company or Social Security.
Health Insurance
If someone is unemployed and needs money for health insurance, they can take money out of their IRA account. But they need to have been unemployed for 12 weeks first.
The Account Holder Dies
When someone who has an IRA account dies, the inheritors can take money out of the account without paying the penalty. But if you are married and inherit your spouse’s IRA and transfer the account to yourself, you may have to pay the penalty if you take money out before age 59 1/2.
Unpaid Taxes
The IRS might come after your IRA and place a levy on it. You can take a withdrawal penalty-free if this happens.
Purchasing Your First Home
You can use your 401(k) money to buy a house. But you will pay a 10% penalty.
You can take money from your IRA without a penalty. You do not have to be a first-time home buyer, but you cannot buy another house if you’ve owned a home in the last two years. You can take more than one withdrawal for a home, but there is a $10,000 limit over a lifetime.
Expenses For a Higher Education
If you have a 401K, you may be able to use it to pay for education. But there is a 10% penalty.
However, if you use IRA withdrawals to pay for qualified expenses, there is no penalty.
Expenses include books, tuition, supplies, room and board, and post-secondary education.
72(t) Distributions
Section 72(t) of the tax code is a law that allows people to take money out of their retirement accounts with restrictions.
72(t) income distributions require substantially equal periodic payment for five years or until you reach age 59 1/2, whichever is longer.
Rule of 55
If you are 55, the IRS will not charge you a 10% penalty if you take money out of your 401k or 403b account. Here are the guidelines to qualify:
You must leave your job when you are 55 years old or older.
If you retire or are laid off before age 55, you will pay the penalty for taking money out of your 401(k) plan. But if you retire or are laid off after age 55 (age 50 if you’re a public service employee), you won’t have to pay the penalty.
The Rule of 55 only works if you’ve left your job in the year you turn 55 or later.
Some employers may not want you to take out your retirement savings early.
You Can Only Withdraw From Your Current 401(k)
Penalty-free early withdrawals are limited to funds held in your most recent company’s 401(k) or 403(b).
You cannot use money from your old 401(k)s.
The Rule of 55 does not apply to IRAs, so do not take money out of your IRA account if you want to avoid the penalty.
Before leaving your old job, roll your old 401(k) into your current 401(k). This will allow you to access the money when you are 55.
Tip: If you exercise the Rule of 55, roll an old 401(k) into a deferred annuity with an inflation-adjusted income rider. Once you turn age 59.5, turn on the income rider to start receiving your retirement income (with increases) for the rest of your life, even if the 401(k) runs out of money.
You Can Collect Penalty-Free Withdrawals And Still Work
People over 55 can still work and take money from their 401(k) account without penalties.
A Natural Disaster
Congress enacted special tax relief by reducing tax penalties for people living in certain areas declared disaster zones. As a result, they can now use their retirement money to recover from disasters while they live there.
People under 59 ½ whose homes got damaged in a federally qualified disaster avoided the 10% early withdrawal penalty.
Qualified Reservist
A qualified reservist is a military reserve member who is not active. When called to active duty, they can withdraw early from an IRA or 401(k) without incurring the usual 10% early distribution penalty.
Can I Take Money Out Of My Roth IRA?
You can take money out of your Roth IRA under certain circumstances.
Since you have already paid taxes on your Roth IRA contributions, you can generally withdraw them without any added charges or penalties. With a Roth IRA, this is an incredible opportunity to access your money whenever necessary!
However, if you withdraw earnings from your Roth IRA before meeting specific requirements, you may have to pay taxes and penalties on the amount you withdraw.
To access your earnings tax-free and penalty-free from a Roth IRA, you must meet the required criteria listed below:
- First, the Roth IRA must have been open for at least five tax years.
- Second, you must be at least 59½ years old.
- Third, it would be best if you were permanently disabled.
- Finally, you must use the funds for a first-time home purchase (up to a lifetime maximum of $10,000).
If you do not meet these requirements, you may still be able to withdraw earnings from your Roth IRA, but you may have to pay taxes and penalties on the amount you withdraw.
It’s essential to carefully consider the consequences of withdrawing money from your Roth IRA before you do so. Withdrawing money from your Roth IRA can reduce the balance of your account and may affect your long-term financial goals. Therefore, it’s generally a good idea to consult a financial professional before withdrawing money from your Roth IRA.
Next Steps
If you are thinking of withdrawing money from your IRA or 401(k) before you reach the age of 59 1/2, be sure to check and see if your distribution is exempt from the 10% penalty. You might be able to avoid that pesky penalty by taking a distribution for specific reasons. To find out more, request a quote today. We can help you understand all the details so you can make an informed decision about your retirement savings.
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Frequently Asked Questions
When can I withdraw from an IRA?
You can avoid the early withdrawal penalty by waiting until at least 59 1/2 to start taking distributions from your IRA. Once you turn 59 1/2, you can withdraw any amount from your IRA without paying the 10% penalty.
When can I withdraw from a 401(k)?
You can avoid the early withdrawal penalty by waiting until at least age 59 1/2 to start taking distributions from your 401(k). Once you turn 59 1/2, you can withdraw any amount from your 401(k) without paying the 10% penalty.