Withdrawing money from an IRA can be confusing. There are rules for various situations, especially if you need to withdraw money before you are the correct age. Since IRA contributions are made with money that has not been taxed, the rules are strict, especially when compared to rules regarding Roth IRAs, which are funded through post-tax dollars.
If you have received an IRA through an inheritance, understanding your inheritance can be tough, too. In most cases, you have to be 59 ½ to withdraw without being penalized 10 percent. However, there are some strategies that can help you maximize the IRA.
Before you decide to withdraw money from your IRA, even if you are not charged a penalty by the IRS, you should meet with your financial adviser. States and municipalities have different rules about investments and penalties than the federal government. You might have to pay fees to your local or state government.
Along with understanding the fees and penalties that you could pay for early withdrawal, you should also know about the forms you have to complete. Your financial adviser or tax preparer will know what you need to complete so you are compliant.
Before you withdraw from your IRA, you should decide what is best for your personal needs. Withdrawing money from a retirement plan like an IRA should not be taken lightly. All of your options should be explored along with a professional who understands retirement planning.
You are a Beneficiary
If you have inherited an IRA, you might not be required to pay the 10 percent withdrawal penalty, but there are a few exceptions. If you are the husband or wife of the original owner of the IRA, then you probably have to pay the early withdrawal penalty. The sole beneficiary will also have to pay the penalty. You will also have to pay the penalty if you received the IRA through spousal transfer.
However, if you are the beneficiary and not a spouse of the original owner, you should be able to withdraw money from the IRA without having to pay a penalty. To avoid the penalties, it is important that the withdrawal forms are filled out properly. An IRA trustee or financial advisor should be able to help you with the IRS 1099-R form that you must submit to the federal government.
You are Active in the Military
Being on active duty in the military is one way to withdraw money from an IRA without paying penalties. As with any early withdrawal, there are specific rules. One is that you must be actively on duty after September 11, 2001. Qualified reservists can also make early withdrawals thanks to a program called the HEART Act which gives service members some ways to ease the financial struggles that can come with moving from active duty into civilian lives.
Before you withdraw money from an IRA, be sure that you are qualified to do so. There might be situations where you have to repay distributions within two years of the end of your active duty. There are rules about how many days you have to be actively serving the US military to withdraw without penalties. The distributions must be done while you are serving.
It is also important to consider whether it is in your best financial interest to withdraw IRA funds early. When you withdraw funds, they are no longer collecting interest. It is wise to look at all of your options and what will benefit you the most in the present and future.
You Owe the IRS
Ironically, if you owe the IRS money on an unpaid tax bill, you can use your IRA to pay the debt. If you give the IRS the ability to get to the money in your IRA account, they will not charge you the 10 percent penalty. The IRS will not allow you to withdraw the money first, then pay them. If you do not pay them following their rules with IRA withdrawals, you will have to pay the penalty.
This is a good deal for anyone who owes the IRS a substantial amount of money. While using an IRA to pay an IRS tax debt can drain your retirement account, the penalties and interest on IRS debt can be rather expensive, too. Avoiding a 10 percent penalty and using pre-tax dollars to pay an IRS debt is often a better deal than paying the interest that often exceeds 10 percent and continues to grow as it goes unpaid. Of course, it is best to speak with your financial advisor or tax preparer before you give the IRS access to your IRA.
You Want to Buy a House
The IRS allows homebuyers to use up to $10,000 of their IRA to buy a home. The IRS puts a life-time limit on $10,000 and to qualify for the penalty-free withdrawal, you have to be a first-time homebuyer. According to the IRS, that means you can’t have purchased or owned a home without the last two years. If you have two or more IRAs in your name, you can still only use $10,000 in total over the course of your life for the home-buying withdrawal.
Married homebuyers can use $10,000 from his-and-her IRAs, so you can use $20,000. The IRS also allows IRA owners to withdraw $10,000 to give to family members, like children, parents, or grandchildren, so they can buy homes, too. Of course, the family members must also be first-time homebuyers, too. If you are sharing $10,000 from your IRA with a family member, you can be a homeowner.
It is important to remember that there are other options for making a down payment on a home. Withdrawing from an IRA might be an immediate solution, but it does remove money from your retirement plan.
You have College Expenses
The IRS recognizes that college is expensive. If you have qualified higher education expenses, you might be able to withdraw from your IRA to cover the costs. The withdrawal can pay for educational expenses for you, your child, or your spouse.
The qualified higher education expenses include things like tuition and fees and the supplies necessary to complete the classes. The IRS does not remove the withdrawal penalty to pay for athletic fees or living expenses. However, there are some allowances for students who live on campus and are enrolled half-time or more. The IRS does put limits on what can be spent.
Your tax professional or financial planner can help you better understand if an IRS withdrawal is the best choice for paying for school. Financial aid might be a better choice rather than emptying your IRA.
You are Unemployed with Health Care Expenses or a Disability
Health insurance premiums can wreak havoc on a family’s budget. If you are unemployed and you are still paying health insurance premiums, that havoc only increases. Fortunately, the IRS understands how tough it is to make payments on health insurance premiums without having a guaranteed income. The IRS allows people to withdraw money from their IRA if they are in this situation. But, there are strict requirements that must be met.
The requirements for penalty-free withdrawal from an IRA while unemployed and paying health care expenses include having received 12-weeks of unemployment payment. The compensation must come after you have lost your job and you did not withdraw within 60 days of returning to work. You can only withdraw money from your IRA during the year or year after you received unemployment payments.
Along with being able to withdraw without paying a penalty for being unemployed and having to pay for health care, you can also withdraw if you have a disability that prevents you from returning to work. There are not any limitations on how you can use the money and on how much you can withdraw. The IRS will ask you to prove that you are permanently disabled and can no longer work.
You have Medical Expenses
Medical expenses are the bane of many families. Health insurance is expensive and not having is even more expensive. Out-of-pocket medical expenses, even deductibles, can break the bank. The IRS allows you to use your IRA to pay for out-of-pocket medical expenses with having to pay the 10 percent penalty.
As with all of these penalty-free withdrawals, you should find out whether or not you qualify for them. The cost of the expenses has to meet some requirements. The first is that they must all be accrued during the same calendar year. The second is that they must exceed a set percentage of your adjusted gross income.
Your tax preparer or financial adviser can help you determine if you qualify for the waived penalty. The amount you can withdraw without paying a penalty is based on your adjusted gross income. There are other ways to pay for medical expenses, but for some people being able to cover it with their IRA is the only way to go.