Your contributions to your IRA (individual retirement account) are an excellent way to supplement your income when you retire and enter that beautiful phase of your life. However, as much as you would love to keep your IRA locked up until retirement, unforeseen expenses may force you to seek those assets.
Your Roth or Traditional IRA withdrawal may trigger a mandatory 10% penalty if you take money out too soon, but there are several instances where you can avoid paying that.
Continue reading below to learn more about penalties associated with IRA accounts, ways to avoid paying those penalties, and who you can reach out to for any questions or concerns about your accounts.
Roth IRA Withdrawal Rules
Your Roth IRA contributions are made with after-tax dollars. This means that you can withdraw your own contributions at any time and at any age without penalty or tax.
After you withdraw an amount equal to your contributions, your earnings will only be taxable if the distribution is not a qualified one. If it is, you won’t be taxed.
Converted Amounts and Early Withdrawal Penalty
If you plan on converting your traditional IRA to a Roth IRA, there is a tax you need to be aware of. This is the conversion tax. After you pay that, you won’t have to worry about paying taxes again on that IRA, even if the future tax rates change.
However, the rules for Roth IRA withdrawal differ for Roth conversions. If you wish to take a tax-free distribution, you have to keep the money in the Roth IRA for five years after the conversion.
If you withdraw before those five years, you may need to pay the 10% early withdrawal penalty. However, if you are at least 59 1/2 when you make that withdrawal, you won’t need to pay that early withdrawal penalty.
Distribution Ordering Rules
If the money you wish to withdraw from the Roth IRA is not a qualified distribution, part of that amount may be subject to taxes. Your money comes out of your Roth IRA in a specific order: regular contributions, conversion contributions, and earnings on contributions.
Required Minimum Distributions for Roth IRAs
There is no mandatory IRA withdrawal requirement for a Roth IRA. This means that you don’t need to withdraw any money while alive. This provides you with a considerable advantage over a traditional IRA.
If you’ve held the Roth IRA account for at least five years and you’re older than 59 1/2, any money you wish to withdraw won’t get taxed. If you open this account after you turn 59 1/2, you must wait five years before taking distributions without paying the penalty tax. However, you still have the opportunity to take withdrawals of your contributions whenever you need to without paying the tax.
Traditional IRA Withdrawal Rules
If you wait until you are 59 1/2, you won’t have to pay the tax penalty with a traditional IRA. The money you withdraw is taxable if you deduct your traditional IRA contributions. However, a portion of your withdrawal is free of taxes if you contributed nondeductible funds.
Traditional IRA Rules After Death
If a person dies while there is still money in their IRA account, the beneficiaries only pay taxes on distributions the deceased would have paid. This does not matter if the money is inherited.
Traditional Mandatory IRA Withdrawal
As a required rule, you must start withdrawing money from your traditional IRA account once you meet a certain age. There are two starting ages: 70 1/2 and 72.
If you were born on or before June 30, 1949, you must begin pulling money from your Traditional IRA account at 70 1/2. Anyone born after July 1, 1949, must start at 72.
Your plan requires that you make your first distribution by April first, after the year you reach the required age. It is also essential that you make subsequent withdrawals by December 31 each year. If you fail to do so, you may face a penalty around 50% of the amount you were supposed to distribute.
Delayed Required Minimum Distribution
Although the Traditional IRA allows you to delay your first required minimum distribution to the following year, you should take your first distribution when you’re eligible. When you do this, you avoid taking two distributions the following year.
How to Avoid the Withdrawal Penalty
As mentioned earlier, the Internal Revenue System imposes a 10% penalty on early withdrawals from your IRA accounts. These fees are in place to encourage you to keep your retirement savings in your account so that you can have them for your non-working years.
There are situations where you can take an early withdrawal from your IRA accounts without facing the penalty fee. For example, if you don’t have health insurance, you may be able to take penalty-free distributions from your IRA to cover those expenses.
Paying for Medical Care
As stated above, if you don’t have health insurance, you can use your IRA to pay for your medical expenses. There are cases where your health insurance does not cover certain medical expenses. If you are in that predicament, you can also use your IRA funds to cover those expenses.
In order to qualify, your medical expenses must be within the same year you take your distribution. In addition to that, your unreimbursed medical expenses need to exceed 10% of your tax year adjusted gross income tax.
For example, if your adjusted gross income tax for the year is $200,000 and your unreimbursed medical expenses are around $30,000, you can only distribute up to $20,000 without facing any penalties.
If you become permanently disabled and you can no longer work, the IRS will allow you to withdraw money from your IRA without paying the penalty. You can use the money from the distribution for whatever you need. Just keep in mind that before your plan administrator can provide you with the funds, they will need proof of your total disability.
Unemployed Health Insurance
If you are unemployed, you may be able to take money out from your IRA to pay for health insurance premiums. There are a few conditions you must meet before taking out your distribution penalty.
Here are the conditions you must meet:
- You receive the money no later than 60 days after going back to work
- You took the distribution during the year or the following year; you received unemployment income
- You lost employment
If you are unsure if you’ve met these conditions, you can reach out to experienced tax attorneys for more help. They can look over your situation and let you know about your eligibility status.
You Inherit an IRA
If you are the beneficiary of an IRA, your withdrawals are not subject to the 10% penalty tax. If you are the sole beneficiary, are the account holder’s spouse that exception does not apply to you.
In this case, the IRS treats this inherited account as if it was yours in the first place. With that said, you will need to pay the 10% early withdrawal penalty.
Called to Active Duty
You are not subject to the early withdrawal penalty if you are a qualified reservist. These distributions are made to the National Guard member or military reservists called to active duty for at least one hundred seventy-nine days. If you decide to take your distributions, make sure that you pay them within two years after the end of your active duty.
To Buy or Rebuild a Home
If you wish to purchase, build, or rebuild a home, you can use up to $10,000 from your IRA. You must be a first-time homebuyer to qualify for this exception, which means you have not owned a house in the previous two years. Even if you’ve owned a house before, you can still qualify as a first-time homebuyer today.
If you are married, your spouse can also take $10,000 from their IRA. If you wish to help your children or grandchildren purchase their first home, you can withdraw $10,000 from your account for them as long as they are also under the criteria of a first-time homebuyer.
Higher Education Expenses
Getting your college degree nowadays is much more expensive than it ever has been. If you plan on footing the bill for higher education, you have the opportunity to use your IRA to pay for qualified education expenses. You can use your assets to pay for your children’s or your spouse’s college.
Qualified higher-education expenses include the following:
Students enrolled at least half-time can use their IRA to cover room and board without paying the 10% penalty tax. If you are unsure what expenses qualify, you can reach out to your trusted, qualified tax attorneys. You can also check in with the school to ensure it satisfies your requirements to be a part of the chosen program.
To Fulfill an IRS Levy
The IRS can take funds from your IRA account to pay your federal taxes. The penalty won’t apply if the IRS levies the money directly from your account.
If you withdraw the money on your own to pay the IRS, you must pay the penalty tax fee. Your tax attorney can work with the IRS to ensure they take the money directly from the account, so you don’t have to pay that fee.
Substantially Equal Periodic Payments
If you must make regular withdrawals from your IRA over a few years, there are ways to access the funds you need without paying the penalty fee. There are specific requirements you must meet to have this exception.
You can take substantially equal periodic payments from your IRA account under the IRS’s pre-approved methods each year for five years or until you turn 59 1/2.
COVID-19 IRA Repayment
Because the Coronavirus pandemic put such a financial burden on the people of America, the CARES Act made it easy for affected Americans to take distributions from their qualified accounts. In 2020, you were allowed to take up to $100,000 from your retirement accounts without paying the 10% early withdrawal penalty.
Anyone who took out the coronavirus-related withdrawal can pay part of it, or all of it, provided they complete the repayment within three years. There is also no federal income tax owed on this distribution.
Can I Use an IRA to Adopt a Child?
The birth of a child or a legal adoption is considered an exemption so that you can use your IRA for those related expenses. When you adopt or give birth to a child, you can withdraw up to $5,000 from your IRA if it is within the first year.
IRA Contributions Over 50
The contribution limit for people over 50 is $7,000 per year as of 2022. This includes a contribution of $6,000 plus an additional “catch-up” contribution of one thousand dollars. If you wish to contribute this full amount to your Roth IRA, you must meet a few requirements.
If you are married and filing jointly, your modified adjusted gross income must be under $204,000. If you are a single filer, it must be less than $129,000.
Contact Experienced Tax Attorneys for More IRA Information
It is also essential to note that the above ways to avoid the early withdrawal penalties may still be subject to state and federal taxes. Even though they may be subject to those taxes, at least you have ways to maximize and utilize your IRA without any additional fees.
Contact us now if you need to access funds from your IRA or have questions about the best tax strategy to use for your Roth or Traditional IRA. We are here to answer any questions or concerns you have about your IRA or IRA withdrawal rules.