Exceptions to the 10% IRA Early Withdrawal Penalty
Sometimes circumstances can force you to take money out of your traditional IRA earlier than you'd planned. This type of withdrawal will be taxed and it can also be subject to an early withdrawal penalty. But there are some early withdrawal exceptions to these rules. Various situations might qualify you for an exception to the IRA penalty tax on withdrawals taken before you reach age 59½.
CARES Act Withdrawals
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) introduced a penalty-free withdrawal option for those impacted by the coronavirus. Affected individuals can withdraw up to $100,000 without an early withdrawal penalty until December 20, 2020. You must meet one of the following qualifications to make a withdrawal:
- You, your spouse, or a dependent is diagnosed with COVID-19.
- You're experiencing financial consequences from COVID-19, including not working due to being quarantined, being furloughed, being laid off, or you have a reduction in hours.
- You're experiencing financial consequences because you don't have adequate child care due to COVID-19.
- You own a business and you had to close or reduce hours due to COVID-19.
Although you don't have to pay an early withdrawal penalty for these withdrawals, you'll owe income tax, just as you would with other withdrawals. But you have three years to pay those taxes and three years to repay the money to your IRA under the terms of the CARES Act if you choose.
You Spent the Money on Medical Expenses
You might qualify for an exemption from the IRA penalty tax if you use your IRA early withdrawal to pay for medical expenses that are more than 7.5% of your adjusted gross income.
You Spent the Money on Health Insurance
You might be exempt from an early withdrawal penalty if you're unemployed, you used the IRA early withdrawal to pay your medical insurance premiums, and you meet three additional requirements:
- You received unemployment compensation paid under federal or state law for 12 consecutive weeks because you lost your job.
- You took the IRA withdrawal during either the year you received unemployment compensation or the following year.
- You can't have taken your IRA withdrawal more than 60 days after your new employment started if you've since been re-employed.
Get a doctor's verification to qualify for an exception to the penalty tax if you're disabled. The IRS indicates that you're considered to be disabled if you can't perform any substantial gainful activity because of a mental or physical condition, but a physician must determine that your condition is likely to be long and continued or even result in death.
If You've Inherited an IRA
You can inherit an IRA in a few ways, and the tax penalty depends on how the transaction occurred.
You won't have to pay the penalty on amounts withdrawn if you inherit from a non-spouse, even if the IRA owner was under age 59½. You'll have to include any IRA withdrawals in your adjusted gross income (AGI), however.
Any IRA early withdrawal you take will be subject to the 10% penalty tax if you inherit from a spouse and you choose to treat it as your own IRA.
You would be eligible to receive IRA early withdrawals without paying the 10% penalty tax if you inherit an IRA from a spouse but you choose to title the IRA as an "inherited IRA."
Internal Revenue Code Section 72(t), the Substantially Equal Periodic Payment (SEPP) rule, lets account holders withdraw money from their retirement accounts at any age without penalty. You can withdraw a set amount of 72(t) payments each year based on your life expectancy. You must follow certain rules and use one of three approved methods to calculate an ongoing withdrawal amount.
You must stick with your withdrawal schedule for a minimum of five years or until you reach age 59½, whichever event occurs later, or all amounts withdrawn can be subject to the penalty tax.
Qualified Higher Education Expenses
IRA early withdrawals used to pay for qualified higher education expenses on behalf of you, your spouse, or the children or grandchildren of you or your spouse are exempt from the 10% tax penalty. The funds can be used for room and board if the student is at least half time, tuition, fees, books, supplies, equipment, and special needs services.
First-Time Home Purchase
Up to $10,000 of an IRA early withdrawal that's used to buy, build, or rebuild a first home for a parent, grandparent, yourself, a spouse, or you or your spouse's child or grandchild can be exempt from the 10% penalty. You must meet the IRS definition of a first-time homebuyer, however.
A first-time homebuyer is someone who hasn't had an ownership interest in a home in the last two years before buying a new home.
You and your spouse can each withdraw $10,000 from your respective IRAs without paying the 10% penalty if you both qualify as first-time homebuyers. The distribution must be used to pay for qualified acquisition costs, which include reasonable closing costs, before the close of the 120th day after the date you receive the money.
Qualified Reservist Distributions
A qualified reservist distribution isn't subject to the penalty tax on IRA early withdrawals. According to the IRS, a qualified reservist distribution must meet the following requirements:
- You were ordered or called to active duty after September 11, 2001.
- You were ordered or called to active duty for a period of more than 179 days or for an indefinite period because you're a member of a reserve component.
- The distribution is taken from an IRA or from amounts attributable to elective deferrals under a section 401(k) or 403(b) plan or a similar arrangement.
- The distribution was made no earlier than the date of the order or call to active duty and no later than the close of the active duty period.
There are no exceptions to paying ordinary income tax on the amounts withdrawn under any of these exemptions, however.