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.
Hardship Withdrawal From IRA
With a 401(k), you are limited in when you can withdraw money, but there are exceptions that allow withdrawals due to hardship. With an IRA, there are generally no limits on when you can take a distribution, so there is no provision for an IRA hardship withdrawal.
However, there are certain expenses that allow you to take early distributions without paying any extra taxes; specifically, you do not have to pay the early distribution tax if you withdraw money from an IRA to fund higher education or to finance the purchase of your first home (up to $10,000). (Sections 72(t)(2)(E),(F)) of the tax code). You can also make a withdrawal without penalty if you will use the money to pay for unreimbursed medical expenses (but only if they exceed 7.5% of your adjust gross income), to pay the premiums on your medical insurance if you have received unemployment benefits for more than 12 weeks, or to pay back taxes after the IRA places a levy against the IRA.
Remember that with a Roth IRA, you are free to withdraw your money at any time and for any reason, with no justification required; while this is generally a bad idea (as you likely won't be able to replace the money, and may owe a penalty if you touch the earnings or any deductible contributions), it does mean that the money is available in an emergency.
2010 IRA Contribution and Deduction Limits
The rules regarding contributions to and disbursements from individual retirement accounts change from year to year based on what Congress does; here's what you need to know for 2010.
If you are under 50 at the end of 2010, you can contribute either $5,000 or your total taxable income for 2010, whichever is less. This limit applies to both traditional and Roth IRAs; you may split the money between them, but the total contribution must be no more than the numbers above. If you are fifty years old or older, the limit is raised to the lesser of $6,000 or your total taxable compensation for 2010, with the same restriction as above.
The income limits for claiming the deduction for contributions to a traditional IRA were raised for 2010, as follows. Note that all numbers refer to the modified adjusted gross income.
If your filing status is single or head of household, you can take the full deduction for contributions to a traditional IRA provided that you made (an adjusted) $56,000 or less; you're entitled to a partial deduction provided your adjusted gross income was less than $66,000. If you are married filing jointly or a qualifying widow(er), those numbers increase to $89,000 and $109,000. However, if you are married filing separately, you're entitled to only a partial deduction and only if your AGI was less than $10,000, unless you did not live with your spouse at any time during the year, in which case the rules for single filers apply.
The above numbers apply if you are covered by a retirement plan at work. If not, and you are single, head of household, a qualifying widow(er), married filing jointly, or married filing separately with a spouse who isn't covered by a plan at work, then you can take the full deduction regardless of your AGI. If your spouse is covered by a plan at work, then your limit is $167k for the full deduction, $177k for a partial deduction if filing jointly, $10k for a partial deduction if filing separately.
For a Roth IRA (which doesn't come with a tax deduction), your AGI may affect how much you can contribute. If you are single, head of household, or married filing separately and you did not live with your spouse at any time during the year, you can contribute up to the limits discussed above provided your modified AGI is less than $105k, and a reduced amount as long as it is under $120k. If you're married filing separately and lived with your spouse at any time during the year, you can contribute a partial amount if you made less than $10k. If you are married filing jointly or a qualifying widow(er), you can contribute the full amount if you make under $167k and a partial amount if you make less than $177k.
Another change for 2010 is the elimination of the filing status requirements for converting a traditional IRA to a Roth IRA, and the provision for extra catch-up contributions for certain employer bankruptcies no longer applies. Additionally, the provision allowing tax-free distributions from IRAs for charity is expiring and is no longer available.
The IRA distribution rules for 2010 state that if you made contributions to an IRA in 2009, you could withdraw them tax free at any time up until your tax return was due (either the original due date or the extended due date, if you filed for an extension); however, you may not take a deduction for the contribution and must withdraw any interest earned on that amount (in case of a loss, the amount of interest may be negative).
You must begin receiving distributions from your IRA by April first of the year after you reach age 70 1/2. However, there is an exception in 2010: if you reached this age last year, you do not have to begin taking disbursements at the normal time, but must take the first one by December 31, 2010.
You may take more than the required minimum, if desired, but this does not reduce the amount that you must take in future years. (The exception is that you can count money withdrawn in the year you turn 70 1/2 against the next year, when you would have your first minimum disbursement). The minimum required distribution varied based on the account balance and can be found by referring to the table provided by the IRS. Failure to withdraw the correct amount or more subjects you to an excise tax.
Roth IRA vs 401(k)
There are a great number of different retirement plans out there, but the two most common are the 401(k) and the Individual Retirement Account (IRA); each have their advantages and disadvantages. There’s a good chance that you want to have both!