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6 ways to avoid the IRA early withdrawal penalty

by ezTaxReturn Expert Staff | Mar 26, 2021 | General Discussion, Personal Finance, Retirement & Social Security, Tax Tips & Planning

IRA Early Withdrawals
Reading Time: 3 minutes

An IRA is supposed to help you save for the future, so you can live comfortably in retirement.  To keep you focused, there are strict rules about when you can access the money.  Typically, you’ll need to wait until you’re at least 59 ½ to withdraw the cash.  If you dip into your IRA before then, you’ll face a 10% penalty unless you qualify for an exception.  Keep in mind that although an early withdrawal may be allowed, it’s not the best move, so explore other options first.  If you’re still thinking about cashing out your IRA, here are some ways to do it penalty-free.

Disability

One in 4 adults in the U.S. is living with a disability.  If you become permanently disabled and can no longer work, you can make penalty-free withdrawals from your IRA.  However, you must be able to provide proof of your mental or physical disability from your doctor.

Pay for college

According to the College Board, the average tuition and fees for a full-time student attending a public four-year in-state college is $10,560 for 2020-21.  That number jumps to $37,650 for those attending a private nonprofit four-year college.  With those price tags, it’s no surprise that many parents dip into their retirement accounts to try to cover the expense.  The good news is you won’t be penalized for doing so.  You can use the funds to send yourself, your spouse, children or grandchildren to college.  The money must be used to pay tuition, fees, books, supplies or room and board. 

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Buy your first home

When you’re ready to buy a home, experts suggest putting a 20% down payment.  Unfortunately, most people don’t have that much cash readily available, so they turn to their retirement accounts.  First-time homebuyers can withdraw up to $10,000 ($20,000 if you’re married and your spouse is also a first timer) to buy, build or rebuild their first home.  The IRS defines a first-time buyer as someone who hasn’t owned a home in the last two years.  If your home purchase or construction is canceled or delayed, you must put the money back into your IRA within 120 days to avoid taxes and the penalty.

Pay off your medical bills

If you have out-of-pocket medical expenses that aren’t covered by insurance, you may be able to make a penalty-free withdrawal.  To qualify, the money must be used to pay unreimbursed medical expenses that exceed 7.5% of your adjusted gross income.

Get health coverage while unemployed

According to the United States Department of Labor, around 10 million people are out of work.  Most people lose their health insurance when they lose their job.  While there may be other things you’d rather buy with your money, going without health coverage can be an expensive mistake if you get sick or injured.  So don’t skip it. If you’re unemployed for at least 12 weeks, you can use the funds from your IRA to pay for health insurance for you and your family.  To qualify, you must meet the following criteria:

  • You lost your job
  • You received unemployment compensation for 12 consecutive weeks
  • You took the distribution the same year you received unemployment compensation or the following year
  • You receive distributions for no more than 60 days after going back to work

Wait until you reach age 59 ½

Dipping into your retirement account early isn’t a great idea.  You’ll miss the chance to earn more compound interest and have less money when you retire.  If you want to avoid the early withdrawal penalty, the best thing to do is be patient and leave the cash alone.  When you’re age 59 ½ you can start making withdrawals without penalty or let the money continue to grow.  If you have a traditional IRA and turned 70 after July 1, 2019, you don’t have to take any required minimum distributions until your 72nd birthday.

Related posts:

6 money-saving tax credits for parents
5 Tax Tips to Lower Your 2018 Tax Bill
5 Beneficial Tax Credits

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