Taking Money Out of an IRA Penalty-Free – 7 Ways

by Neal Frankle, CFP ®

If you are interested in taking money out of an IRA penalty-free, there are a number of ways to do this. But first let’s see why it’s so important to stick to the IRA rules.

Let’s say you have $3,500 in credit card bills that you want to pay off with IRA funds. If you are in the 30% tax bracket, you’ll need to withdraw $5,000, pay $1,500 in tax and have $3,500 left over to pay the credit card bill. If you are under 59 1/2, you may need to pay an additional $500 penalty to the IRS. Ouch. If you get that $500 from the IRA, you’ll incur more income taxes and more penalties. It’s a vicious cycle.

If you borrow from your IRA and fail to pay it back, you’ll incur the same expense, tax and penalties.

So you can see that it’s very expensive to use your retirement account to pay your bills. (But on the other hand, it is a great way to end up needing a job during retirement.) However, there is some good news. There are 7 ways you can take money out of your IRA without paying a penalty.

1. School

If you use IRA money to pay for higher education for yourself, your spouse, children or grandchildren, you can tap those IRA funds penalty-free. Of course you should make sure the school is on the IRS-approved institution list. The good news is that eligible schools include colleges, universities, vocational schools and private vocational schools. The school must be accredited, but it can be private, public or not-for-profit.

2. Home Sweet Home

If you haven’t purchased a home within two years, you can use up to $10,000 from your IRA to do so without paying a penalty. If you are married and your spouse is in a similar situation, you can pull $20,000 for your retirement accounts penalty-free and use the money for a down payment for your home purchase.

If you want, you can take that money and give it to your parents, kids or grandkids and let them use the money to buy a home if they haven’t purchased one within two years.

In order to take advantage of this technique, you have to use the IRA money within 120 days to buy the home.
Now, if your IRA is a Roth IRA, your $10,000 withdrawal is tax-free and penalty-free as long as you’ve held the Roth for at least five years.

3. If you are permanently disabled

This isn’t the most attractive way to withdraw your IRA money without the 10% penalty, but it does work.

4. IRA owner dies

This is even worse than disability, but if you die prior to age 59 ½ and your family makes a total withdrawal from the IRA (not recommended), they’ll pay income taxes but escape the 10% penalty.

5. Withdrawals are used to pay non-reimbursed medical expenses

If you get seriously sick or hurt, you can make withdrawals from your IRA penalty free – as long as the medical expense exceeds 7.5% of your AGI.

6. Paying off an IRS levy against your IRA

If you get smacked with a levy against your IRA, you can take the money out of the account, pay the levy and then the tax, but at least you won’t have to pay a penalty.

7. Health insurance premiums

If you are unemployed for longer than 12 weeks, you can use your IRA funds to pay your health insurance premiums without worrying about the 10% penalty.

Two Items to Keep in Mind:

First, in order to escape that 10% early withdrawal penalty, you have to own the IRA for at least five years. You can’t deposit the money this year and take advantage of these 7 tips the following year. Next, and most important, you should take every precaution possible to make sure you never have to access your money for the reasons stated above.

For example you can:

1. Avoid getting into debt for higher education.
2. Buy a house you can afford.
3. Have your own disability policy.
4. Have enough life insurance.
5. Get a side job that will provide emergency income in case you need to replace your job.

Above all, the best way to stay clear of IRS trouble (and the need to tap your IRA prematurely) is to track your spending and make sure you live below your means.

Have you ever had to take money out of your IRA prematurely? Why? What steps did you take to make sure you wouldn’t ever do it again?

Other Posts of Interest:

IRA FAQs

Roth IRA Conversions – When They Make Sense and When They Don’t

Outside Resources:

IRS FAQs Regarding IRAs

 

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