The annual pre-tax or after-tax contributions you make towards a 401k retirement savings plan is meant to help you have sufficient income upon your retirement. However, there might be immediate times when you desperately need the money, examples include huge medical bills, death of spouse, disability, etc. If you withdraw money from your IRA account before the age of 59 and 1/2, you will be subject to a 10% early-distribution penalty as well as local and federal state taxes.
However, the IRS allows you to withdraw money from your IRA on certain occassions including:
1) Medical Insurance
If you lose your job temporarily and are unemployed, you can withdraw penalty-free early distributions from your IRA to pay for your medical insurance. In order for this distribution to be free, your circumstances must meet the following criteria:
– You lose your job
– You’ve been receiving unemployment insurance benefits under federal or local state laws for atleast 12 consecutive weeks
– You receive the distributions no more than 60 days after being re-employed again (getting a new job or resuming your old job)
– You receive the distributions in the same year as you are unemployed or 1 year later.
2) Buying a Home for the First Time
If you are a first time home buyer, the IRS will allow you to withdraw upto $10,000 of penalty-free distributions towards the down payment and closing costs of the mortgage process. “First time home buyer” is defined as someone who hasn’t owned a new home for atleast 2 years (including their spouse). This penalty-free withdrawal is allowed only once in your lifetime.
3) Unexpected Medical Bills
If you do not have health insurance coverage or face a huge unexpected medical bill (which is more than what your health insurance can cover), you are eligible to get penalty-free IRA distributions. The maximum penalty free distribution that you can get is the difference between the unexpected medical bill and 7.5% of your Adjusted Gross Income (AGI). Here’s a hypothetical example that will clarify this concept:
Your Adjusted Gross Income = $80,000
Your Un-reimbursed Medical Bills = $12000
7.5% x Your Adjusted Gross Income = $6000
Penalty-Free IRA Distribution = $12000 – $6000 = $6000
In the above example, your eligible penalty-free IRA distribution is the difference between the Unexpected Medical Bill of $12000 – 7.5% of your $80,000 annual income ($6000).
4) Higher Education Fees
If you take university courses, you are eligible to get penalty-free IRA Distributions to cover expenses such as fees, tuition, books, supplies, etc. Only certain universities and colleges are eligible for higher education expenses. Check with your tax advisor to see if the courses you are taking are eligible for penalty-free IRA Distributions.
5) Mental or Physical Disability
If your doctor certifies that you have some type of mental or physical disability that does not allow you to work (and thus earn employment income), then you are eligible to get penalty-free IRA Distributions. Always have a doctor’s certificate in case of an audit from the IRS.
6) Inherited IRA Wealth
If you are the beneficiary of someone’s IRA Savings, any distributions you withdraw from that IRA is not subject to early-withdrawal penalty of 10%. Be sure to tell your IRA Administrator to inform the IRS that the distributions you are making from inherited IRA accounts are “death distributions” and not subject to early-withdrawal penalty fees.
