Investing money in an individual retirement account is often the easy part — for some, it’s as effortless as signing up through an employer and keeping it on autopilot until retirement. The tricky part can be knowing when and how to withdraw retirement money to maximize your savings and avoid penalties — and still make sure your needs are met.
Withdrawing money from your retirement investment too soon or too late can incur fees. Understanding IRA rules, as well as exceptions to those rules, can help you avoid a surprise bill from the IRS. Take a look at these rules so you know exactly what IRA funds are available to you and when.
1. Early IRA Withdrawal Can Cost You
Premature distributions — defined as money withdrawn from an IRA before the account holder is 59.5 years old, — will incur a 10 percent penalty, according to the IRS. If you’re enrolled in a SIMPLE IRA, the tax penalty is 25 percent if you withdraw funds within the first two years of participating in the plan.
The tax rules apply to traditional IRA, SEP IRA, SIMPLE IRA, Roth IRAs and SARSEP Plans. There is some good news, however: Exceptions to this rule exist, which include paying for qualifying medical exceptions and education costs.
Related: How to Find the Best Roth IRA
2. You Can Pay for College With IRA Funds
If you need cash to pay for higher education expenses, you can dip into your traditional or Roth IRA for the funds without incurring the usual 10 percent penalty fee for early withdrawal.
This IRA distribution exception is good for qualified college expenses for yourself, your spouse, your children and even your grandchildren. Books, tuition, fees, supplies and equipment are among the qualified expenses. You’re still obligated to pay income tax on the amount that would have normally been subjected to that tax, however.
3. Mind the Mandatory Withdrawal Age
The required minimum distribution rule is that you take your first RMD before or on the date you turn 70.5, with the option to delay the first payment until April 1 of the next year. Forgetting or ignoring the RMD rule can result in a 50 percent penalty tax on the amount you neglected to withdraw.
The amount you must withdraw depends on a few factors, including your account balance and your spouse’s age. The IRS provides worksheets to help you determine how much you have to take out. This rule applies to traditional IRAs and IRA-based plans, including SEPs, SARSEPs and SIMPLE IRAs.
4. Roth IRAs Have No Minimum Distribution
Unlike the RMD of a traditional IRA, Roth IRA withdrawal rules do not require a minimum distribution. As long as the account holder or a spouse who has inherited the Roth IRA is still alive, the money can continue to grow interest untouched. An individual who inherits a Roth IRA from his spouse can treat the IRA as his own; however, a child who inherits a Roth IRA might be subject to the RMD rule.
5. Make a Charitable Distribution to Satisfy RMD
If you’re facing an RMD, one way you can meet the taxable distribution requirements is to donate money to a qualified charity. The tax benefit here is that you don’t have to include that money in your annual gross income.
Except for ongoing SEP or SIMPLE IRA accounts, qualified charitable distributions — also known as charitable rollovers — allow account holders to donate up to $100,000 of required distributions to a charity.
6. Early SIMPLE IRA Withdrawals Mean a Hefty Tax Increase
Before you make an early withdrawal from your SIMPLE IRA within the first two years of participating, consider this: You’ll end up paying a 25 percent penalty tax, which is more than double the usual 10 percent penalty. If you have had the account for more than two years, you will be subject to the lesser 10 percent penalty tax for withdrawing early.
This two-year rule for SIMPLE IRA early withdrawal also applies to rollovers. Only after two years of having the account can you roll over your funds tax-free from a SIMPLE IRA to another account.
7. You Can Tap Into Your IRA for Your First Home
Trying to save enough to buy a house can be tough. Even three percent of the home price — which is an acceptable down payment for loan-seekers with good credit — is more money than many people have saved, especially considering that as of November 2016 the average house cost $359,900, according to the United States Census Bureau.
Using your IRA as a source for a down payment is an option. Individuals who are buying a home for the first time are eligible to withdraw up to $10,000 from an IRA without penalty.
8. Rollover Your IRA the Tax-Free Way
If you need to roll over your IRA funds from one account to another, there are a couple ways you can do it without getting slapped with a tax bill. One way is to have it transferred from trustee to trustee. In this case, you would typically submit a form to the new bank or brokerage firm that will be handling the account. Another way to avoid taxes is by having your financial institution directly transfer the account to the new bank or firm.
If you have a traditional IRA and make the transfer to a financial institution yourself, you will face a 20 percent withholding on the total amount of the transfer. Add 10 percent to that if you’re not 59.5 years old.
9. No Penalty Tax If You’re Disabled
For account holders of traditional, SEP or SIMPLE IRAs, the IRS will waive the 10 percent penalty for early withdrawal if you become totally and permanently disabled before the age of 59.5. You are still obligated to pay the income taxes on the money you withdraw, however.
Roth IRAs are a little different. If your Roth IRA is more than five years old and you withdraw money for disability, those funds are not subject to any tax liability, and you will not be charged a 10 percent penalty, either. If the Roth is less than five years old, however, the penalty is still waived but you would owe taxes on the amount you withdraw.
10. Penalty-Free Emergency Withdrawals Are for Hardships Only
According to IRA distribution rules, you can dip into your IRA early if you face an immediate and heavy financial need. Even if you could have foreseen or prevented that need, the withdrawal might still be counted as a hardship.
If the need is deemed acceptable according to federal guidelines, you can withdraw only enough to cover the cost of the hardship, however. Purchases like televisions and boats, according to the IRS, generally would not fall under the category of a financial need.