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Withdraw from your IRA with no Penalty?

With all the RothMania spreading, especially since the income limits for converting from a traditional to Roth have been removed, I’m afraid that the needed discussion regarding the Traditional IRA has been neglected. So today, I’d like to discuss how you can avoid a penalty while withdrawing money from your IRA, a few better than others.

  • The Section 72(t) Withdrawal – I went into some depth on this one last year, the simple explanation is that you can take a “series of substantially equal periodic payments” for at least 5 years or age 59-1/2 whichever comes second. This is an excellent choice if you are in your late 40’s/early 50’s and either have enough to retire or have other income you know will kick in later, such as a pension.
  • 401(k) withdrawal after age 55 separation. 401(k)?? Where did that come from? Well, you see, most 401(k) accounts permit a transfer from an IRA. So, if you are 55 are know it’s your last year working, you may be able to transfer the IRA into your 401(k) and take advantage of a not so well know rule that permits withdrawals if you leave the company at 55 or older. This leaves you more flexible as you avoid the hassle and term involved with the 72(t). Of course, if the 401(k) fees are high, you’d better think twice before pulling this stunt.

  • Die. Well, I hope not, I need all the readers I can get. But, if you should have a loved one pass on and leave you money in their IRA, your withdrawal are not subject to penalty, just ordinary income tax (unless the IRA is a Roth or have post-tax money in it). Normally, you are required to begin taking RMDs (required minimum distributions) the year after you receive the money, but you don’t have to take more than that.
  • Disability – From IRS Pub 590: You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration. A short term inability to work does not pass this definition.
  • Medical expenses which exceed 7.5% of your adjusted gross income. It’s a pretty high number, hopefully, you’ll never hit it but good to know.
  • “First Time” home purchase. The quotes are not to be cute, the IRS gives you the first time status if you’ve not owned a house for 2 years. If that’s so, you may withdraw up to $10K to use for the purchase and pay tax only, no penalty.
  • Higher education – for you, your spouse, kids, or grandchildren. As with the home purchase, you still don’t avoid taxes, just the penalty. You can take out the full expense, including tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.

That’s it for now, 7 ways to withdraw from your IRA penalty free (but not tax free). I hope you find this useful.

Joe

  • Roshawn @ Watson Inc October 7, 2010, 8:39 am

    I knew about some of these, but some of these exceptions are new to me. Thanks for organizing this for me. Now, I can just file post for retrieval later.

    “Die. Well, I hope not, I need all the readers I can get”
    LOL. (Joe Really? 🙂 )

  • JOE October 7, 2010, 10:44 am

    Glad you found new ones. Too much Roth Mania, not enough regular talk. Thanks for the visit Shawn.

  • Augustine October 7, 2010, 11:49 am

    How about separation or divorce?

  • Sun October 7, 2010, 4:15 pm

    Thanks for posting this. I dealt with cancer treatment for several years. Had I known about the disability clause, I could have applied for minimal disbursements for medical reasons. Instead I paid a 30% early withdrawal penalty. The hospital social workers and financial eligibility people knew nothing about 401k withdrawl other than saying I had to spend down everything I had before I could receive state help for cancer treatment. My advice is to speak with multiple financial advisers if have an expensive medical issues and have retirement assets to handle.

  • JOE October 7, 2010, 4:26 pm

    My understanding is that the court ordered splitting of an IRA (a “transfer incident”, not QDRO as with a 401(k)) does not affect the penalty. The spouse receiving assets still needs to have other issues waiving penalty, such as listed if s/he is not 59-1/2.

  • Elle October 7, 2010, 7:31 pm

    Sun, file an amended return for the appropriate tax years and get that penalty back.

  • JOE October 7, 2010, 8:13 pm

    Excellent idea. You can amend up to three years after original return was due.

  • Sun October 7, 2010, 8:56 pm

    Elle – I don’t know what that mean. What do I amend? You make it sound easier than it probably is. There is the early withdrawal penalty from the 401k, there is the tax penalty, and then there is withdrawal being seen as income. The reported income disqualified me from any state care (I made too much money that year) which forced me to pay out of pocket for very expensive medical scans and procedures. Do I go back to the hospital and ask for a refund as well?

  • Joe Arsenault October 8, 2010, 9:37 am

    May I add something Joe,

    I wrote a piece called “Myth Busting the 10% Penalty”. In my experience most do not realize this penalty only applies to “taxable” gross distributions, with the exception of that one 5 year rule for Roth conversions. This is what I covered and feel almost nobody truly understands. I can’t count the amount of “professionals” that think your entire distribution is subject to the penalty when that is not the case.

    Great piece, I hope you don’t mind me adding this one note to it.

    -Joe

  • Mark October 9, 2010, 3:03 am

    Very useful post especially doing this difficult economic times.

  • Andrew @ Money Crashers October 9, 2010, 11:57 pm

    The one I’d add here is that you can withdraw your initial deposits into a Roth IRA at any time. So if you have added $20,000 to your Roth over 4 years, I believe you can take this $20,000 out at any time (but nothing in excess of it). When I tell people this, they’re shocked, but it’s actually a nice feature of a Roth. Of course if the money is gone because of poor investments, there’s nothing to take out. Is this your understanding too?

  • JOE October 10, 2010, 8:16 am

    I was trying to stay away from Roth completely for this article 😉 but you make a great point I shouldn’t gloss over. I’ll double check and edit my comment here, but I believe the withdrawal of Roth deposits, but not gains, is without limit. I’ve read and made reference to, use use of the Roth account as a college saving fund. In those discussions I’d not seen a $20k limit. I appreciate the visit and comment.

  • Elle October 10, 2010, 8:41 am

    Sun, you amend the tax return for the year(s) you took the early 401(k) distribution. You get back the tax penalty.

    Joe is correct there is generally a three-year time limit. However, this time limit may be suspended for those who are physically or mentally unable to manage their financial affairs. See the amended return instructions under “When To File” on page 2 at http://www.irs.gov/pub/irs-pdf/i1040x.pdf .

    For most people, even those who do their own taxes, an amended return is easy. However for others the research required to do their tax return or amend it is intimidating. It may very well pay for you to go to a professional tax preparer (not H & R Block). If you have questions, try the usenet newsgroup misc.taxes.moderated.

  • Andrew @ Money Crashers October 10, 2010, 12:29 pm

    Oh yeah, the 20k was just for the purpose of the example, but yeah, I don’t think there’s any limit either but let me know if you find out otherwise.

  • JOE October 10, 2010, 1:34 pm

    Got you. Roth has been around long enough, the potential deposits are pretty high, not to mention the Roth 401(k) rollover.

  • Andrew @ Money Crashers October 10, 2010, 1:38 pm

    You raise an interesting one, I’m not sure how the rollover plays into withdrawals. I don’t think you can withdraw that money (it’s not considered a normal contribution to your account) but I’m not 100% sure.

  • Gary October 25, 2010, 9:49 am

    Joe – great website and blog. Question: I will be receiving a pension but I do have a small amount of money in an IRA – the funds were put into the IRA AFTER being taxed – I already paid taxes on the original funds. Would I be able to take the funds out of this IRA for my kid’s education – will I get taxed on the gains?
    What would I have to pay, I am sure there is still a catch even though I already paid taxes on funds that I put into the IRA???? thanks

  • JOE November 6, 2010, 12:58 pm

    If the entire IRA balance is less than the total of your post tax deposits, no tax will be due at all.

  • Glo Dev October 10, 2012, 5:07 pm

    How does one determine the exact date for 59-1/2 to avoid a 10% penalty on IRA withdrawals? Does one count 183 days (1/2 year) from birthday on the year one turns 59 to be safe? How does IRS determine the exact date one can withdraw on an IRA (59-1/2)?

  • JOE October 10, 2012, 5:31 pm

    My understanding has always been that you add 6 months to your birthday month, and that gives you the 1/2 date. So If you were born on 2/15, 8/15 is your half year date.

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