Exceptions to the IRA Early Withdrawal Penalty

One of the most frequent questions we receive is “If I take a distribution from my retirement plan how much will I pay in taxes and penalties”?
Tapping a retirement plan might be just be the financial lifeline you need to cover a short-term financial goal or it could result in paying 35-40% of your distribution in taxes and penalties. Leaving your retirement plans crippled for many years to come.

Let’s review the exceptions to the premature or early withdrawal penalty.
Did you have unusually high medical expenses in 2021? If they exceeded 7.5% of your AGI you could pay for them with an IRA withdrawal. The penalty would not apply to that portion of your withdrawal.

Are you looking for a new home? If you’re potential first time buyer the first $10,000 of withdrawal can be financed penalty free. This can be a big step towards a down payment and it’s a very popular use of your IRA. If you haven’t owned a home in the last two years you can qualify as a first time home buyer.

A new exception to the penalty is the newborn or adoption exclusion. The first $5,000 of withdrawals can be used to pay expenses for adoption or medical or hospitalization costs.

Saving for both retirement and college expenses can be a financial challenge To help with the rising cost of college, parents are turning to retirement funds to partially pay for qualified education expenses. Qualified education expenses include tuition, books, fees, and supplies like computers but not room and board and living expenses.

This exception is for traditional IRA’s and Roth IRA’s. It does not apply to employer sponsored plans like 401-k’s.
Implementing a SEPP to bridge a funding gap until you reach age 59 ½.

Using a SEPP plan (Series of Equal Periodic Payments) may avoid the penalty. You must take distributions every year for 5 years or until you reach age 59 ½. SEPP’s are complicated to calculate and administer to please consult a tax professional before starting his kind of distribution.
Qualified reservists who are called to active duty and people who are totally disabled can also qualify for the penalty exception.
Roth IRA withdrawals are always tax free for your amount contributed (Principle). If the Roth is held for five years or more both the principle, growth, interest, and other earnings are all tax free on withdrawal.

 

This content is for general informational purposes only and should not be construed as professional tax or financial advice for any specific individual tax situation. Taxpayers should always consult a qualified professional for individual guidance.