11 Ways To Avoid Penalties From Your IRA Or 401k

What is the 401K early withdrawal penalty?

Generally, individuals who withdraw money from retirement plans (401k 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 401k penalty exceptions when it makes it possible to withdraw from an IRA and 401k without penalty.

Taxes Owed When Withdrawing From A 401k Or IRA.

Traditional IRA and 401k 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Contributions to a Roth IRA may be withdrawn at any time, and earnings will not incur penalties or taxes (if the Roth IRA has existed for five years).

what reasons can you withdraw from 401k without penalty

1. Unpaid Medical Bills
2. Permanently Disabled
3. Pay for Health Insurance
4. You Die
5. Unpaid Taxes
6. Paying For a Home
7. College Expenses
8. 72(t) Distributions
9. Rule of 55
10. Natural Disasters
11. 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 401k 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 401k 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 401k

Penalty-free early withdrawals are limited to funds held in your most recent company’s 401k or 403b.

You cannot use money from your old 401ks.

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 401k into your current 401k. This will allow you to access the money when you are 55.

Tip: If you exercise the Rule of 55, roll an old 401k 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 401k runs out of money.

You Can Collect Penalty-Free Withdrawals And Still Work

People over 55 can still work and take money from their 401k 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 member of the military reserves who is not on active duty. They have the unique option of making a 401k withdrawal without penalty when called to active duty. This allows them to take funds from their IRA or 401k before the usual age limit without facing the standard 10% early distribution fee.

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:

1. First, the Roth IRA must have been open for at least five tax years.
2. Second, you must be at least 59½ years old.
3. Third, it would be best if you were permanently disabled.
4. 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 401k 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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