11 Ways To Avoid Penalties From Your IRA Or 401(k)

Shawn Plummer

CEO, The Annuity Expert

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.

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 both an IRA and 401(k) without penalty.

Traditional IRA and 401(k)

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Contributions to a Roth IRA may be withdrawn at any time, and earnings will not incur penalties nor taxes (if the Roth IRA has been in existence for 5 years).

How to avoid early withdrawal penalties from your IRA or 401(k)

  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, it must be the same year that the medical bills were incurred.

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 money from your 401(k) 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 account with restrictions.

72(t) income distributions require substantially equal periodic payment for 5 years or until you reach or until 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 when you take 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 you leave your old job, make sure to roll your old 401(k) into your current 401(k). This will allow you to have access to 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 age 55 can still work and take money from their 401(k) account without incurring penalties.

A Natural Disaster

Congress enacted special tax relief in the form of a reduction in tax penalties for people who live in certain areas declared to be disaster zones. As a result, they can now use their retirement money to recover from disasters while they lived there.

People who are under the age of 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 reserve who is not active. When called to active duty, is eligible to make an early withdrawal from an IRA or 401(k) without incurring the usual 10% early distribution penalty.

Shawn Plummer

CEO, The Annuity Expert

I’m a licensed financial professional focusing on annuities and insurance for more than a decade. My former role was training financial advisors, including for a Fortune Global 500 insurance company. I’ve been featured in Time Magazine, Yahoo! Finance, MSN, SmartAsset, Entrepreneur, Bloomberg, The Simple Dollar, U.S. News and World Report, and Women’s Health Magazine.

The Annuity Expert is an online insurance agency servicing consumers across the United States. My goal is to help you take the guesswork out of retirement planning or find the best insurance coverage at the cheapest rates for you. 

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