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  • IRA Early Withdrawal Penalty Exceptions

    While everybody knows they should be contributing as much money as possible to their retirement accounts, the problem is that once you put the money in, you often can't withdraw it without a penalty. This is by design, of course; the whole point is to force you to leave the money alone until retirement. That said, sometimes you end up in a desperate situation and your retirement account is the only place you can get the money you need. Under what circumstances can you take out some or all of your money, while still avoiding the penalty for early withdrawals?

    Fortunately, there are hardship withdrawal exceptions available, but before we get into that, let's look at when you normally can and can't withdraw money from your accounts, and at what penalty.

    Generally, if you contributed to an account using pretax dollars, you can not withdraw without a penalty. If you want to take money out of a traditional IRA, for example, then you have to pay taxes on any money you withdraw (which would have happened whenever you took the money out in any case), plus you owe an additional 10% penalty.

    Normally, the early withdrawal penalty no longer applies once you reach age 59 1/2; at that point, you may withdraw as much money from your IRA as you want, and are required to take a minimum disbursement each year. However, the IRS also recognizes several special cases where you may withdraw money early without penalty; note that you do still need to pay tax on the withdrawals. Also, if you withdraw money during the same year that you contributed it (or rather, before the due date for filing your tax return for that year) then the penalty does not apply.

    The first two are for medical reasons. If you lost your job and received unemployment benefits, then you may be able to withdraw enough money from your IRA to cover the cost of paying for medical insurance during the period of unemployment. Regardless of your employment situation, if your medical expenses are over 7.5% of your adjusted gross income, you can take a penalty-free withdrawal without paying the penalty.

    If you become disabled such that you are no longer able to work, then your withdrawals are not subject to penalty; additionally, if you die before reaching age 59 1/2, then your estate can collect the money from the IRA without penalty.

    Finally, you can use up to $10,000 from the IRA to buy your first home, and can also withdraw as much as you need to pay for college or to roll over into another qualifying plan. If you know you're going to need to take money out of your IRA in the future, but not immediately, you might be able to do a rollover into an annuity that will begin paying out before you need the money. The IRS actually provides a way for you to do this directly, without bothering with the rollover: you can "annuitize" the account and begin taking withdrawals immediately. The catch is that the amount you can withdraw is based on your life expectancy, and you must withdraw the same amount every year for five years or until you reach age 59 1/2, whichever is longer.

    If you only need the money for a brief period of time, IRS rules do allow you to take a 60-day loan from your IRA without paying taxes or penalties, provided the funds are returned within that 60 day period. You can only take one such loan in any twelve month period.

    A SIMPLE IRA files the same rules as the traditional IRA, but if you take the withdrawal in the first two years of participating in a SIMPLE plan, the tax penalty (if it applies) will be 25% rather than 10%.

    In the case of a Roth IRA, you are allowed to remove any contributions you've made, as these are made with after-tax dollars; however, the penalty will apply if you remove any of the earnings, which have not yet been taxed. As with the traditional IRA, there are exceptions if you die, become disabled, or purchase your first home.