Withdraw From Your IRA Without Penalty

September, 2012
by Gerald Townsend, Financial Editor

 Owners of Individual Retirement Accounts (IRAs) have three important ages to keep in mind – note that the following rules apply to regular IRAs and not to Roth IRAs.

Younger than 59 ½ - An IRA owner who withdraws money from their IRA before they reach age 59 ½ will generally have to pay a 10% early-withdrawal penalty in addition to federal and state income taxes.

Older than 59 ½ and Younger than 70 ½ - Between 59 ½ and 70 ½ a withdrawal is subject to regular income taxes, but no 10% penalty is assessed.

Older than 70 ½ - Beyond 70 ½ there is a minimum amount that must be withdrawn and taxed each year, but no penalties apply.

Therefore, if you are under 59 ½ the best financial advice is not to take any distributions from your IRA. After all, this is money that you are saving for retirement, so spending it now can’t be helpful in your retirement planning. But what if you don’t have a choice? A job loss or an unforeseen emergency may require you to take an early distribution, so in that event, are you stuck with paying the 10% early-withdrawal penalty? Maybe not.

While you are stuck with regular income taxes, there are several exceptions to having the pay the 10% penalty:

·         Medical Expenses – Withdrawals for unreimbursed medical expenses that exceed 7.5% of your “adjusted gross income” avoid the 10% penalty. However, this can be a steep hurdle. For example, if your income is $60,000, 7.5% of this equals $4,500. Now suppose you have medical expenses of $8,000. The difference between $8,000 and $4,500 is $3,500 and this is the amount that could be withdrawn penalty-free. It is also important to keep in mind that any medical expenses paid pre-tax through an employer “cafeteria plan” can’t be counted in this calculation.

·         Disability – Distributions made due to a disability that is expected to be “long, continued, and of indefinite duration” are not subject to the 10% penalty.

·         IRA Beneficiary – If you are a beneficiary of an IRA you can take distributions from this IRA before age 59 ½ without a penalty.

·         Annuity Distributions – If you take distributions that are part of a series of “substantially equal payments” that continue for at least five years you can avoid the 10% penalty. This is my favorite method of receiving regular withdrawals from an IRA without incurring a penalty.

·         Educational Costs – A parent with a child in college will appreciate the fact that amounts withdrawn to pay “qualified higher education expenses” also avoid the 10% penalty.

·         First Home – If you have accumulated money in your IRA but are now buying your first home, you’ll be pleased to know that withdrawals for a first-home purchase avoid the penalty. This exception is actually even better than it sounds, because a “first home” just means that you have not owned a home in the past two years. So, even if you did own a home before, you may still qualify for this exception.

Gerald A. Townsend, CPA/PFS/ABV, CFP®, CFA®, CMT is president of Townsend Asset Management Corp., a registered investment advisory firm. Email: Gerald@AssetMgr.com