Anyone who has contributed to an Individual Retirement Account is likely aware of the plan’s primary restriction – namely, that you cannot withdraw the money until you reach the age of 59 1/2.
At the same time, the government didn’t want this restriction to be too onerous, so rather than making it impossible, they simply decreed that if you do so, you will incur – on top of the taxes owed on the earnings that have accumulated – a penalty of an additional 10 percent. This was considered to be sufficient to discourage most taxpayers from arbitrarily raiding their retirement savings prematurely, while at the same time allowing it to be used as a safety net for those undergoing financial stress when younger.
As with most government legislation, special interests (as well as taxpayers themselves) lobbied for various exceptions to the early withdrawal penalty. The result was a number of situations in which the 10% levy for premature withdrawals has been eliminated. (Keep in mind that the tax on the withdrawn pre-tax contributions and earnings will still be owed).
You might be surprised at the number of penalty exceptions allowed. Exceptions are granted:
• After the death of the owner (heirs can withdraw all of an inherited IRA without penalty).
• After the owner becomes disabled.
• For qualified higher-education expenses.
• For purchasing a first-time home (up to $10,000).
• For health insurance premiums paid while unemployed.
• For unreimbursed medical expenses exceeding 7.5 percent of adjusted gross income.
• For certain distributions to qualified military reservists called to active duty.
• For a Roth conversion.
• For rollovers or eligible distributions to another retirement plan or IRA directly (that is, trustee-to-trustee by check or electronically) or within 60 days otherwise. Such rollovers will not incur any taxes at all.
• For excess IRA contributions withdrawn by the extended due date of the return, typically October of the following year. Note that the penalty will still apply to the earnings from those contributions.
Total liquidation
As you can see, there are many ways you can access the money in your IRA before you turn 59 1/2 without incurring a penalty. And if you really fall on hard times, there’s one more exception that’s pretty much a catch-all: the 72(t) distribution (named after the IRS code section in which it’s found). It allows you to completely liquidate the IRA using an annual series of “substantially equal” payments until you reach age 59 1/2 or over five years, whichever is longer.
Despite the fact that you’re allowed to prematurely tap into your IRA under all of these circumstances, please don’t lose sight of the fact that its main purpose is to help you save for your retirement. If you take money out too soon, not only have you reduced the amount saved, but you will also lose all of the growth from those invested savings over the remaining years before you actually retire. Despite the flexibility allowed by the IRS, it’s best to limit any withdrawals before you actually retire to true financial emergencies.
Los Altos resident Artie Green is a Certified Financial Planner and principal at Cognizant Wealth Advisors. For more information, call 209-4062, email [email protected] or visit cognizantwealth.com.
