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 putting contributions 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 so you can use your IRA to reduce your tax burden.
IRA Withdrawal Rules
Before you withdraw money from your IRA, traditional or Roth, make sure you’re making a decision that won’t cost you tons in fees or penalties. Here are IRA withdrawal rules you need to know:
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Premature distributions — defined as money withdrawn from an IRA before the account holder is 59.5 years old — will incur a 10 percent penalty, according to the IRS.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 traditional IRA rules apply to a SEP IRA and SIMPLE IRA, plus Roth IRAs and SARSEP Plans.
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 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.
3. Mandatory Withdrawals From IRAs Begin at a Certain Age
The required minimum distribution rule stipulates you must 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.
4. Roth IRAs Have No Minimum Distribution
Unlike the RMD of a traditional IRA’s RMD, 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.
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.
Keep Reading: How to Know If You Can Really Write Off That Donation
6. Early SIMPLE IRA Withdrawals Mean a Hefty Tax Increase
If you make an early withdrawal from your SIMPLE IRA within the first two years of participating, 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.
7. You Can Tap Into Your IRA for Your First Home
Three percent of a new home’s price — which is an acceptable down payment for loan seekers with good credit — is more money than many people have saved. If you’re a first-time homebuyer, you can use your IRA withdrawal for a home purchase — and withdraw up to $10,000 without penalty.
8. Rollover Your IRA the Tax-Free Way
You can roll over your IRA funds a couple ways without getting slapped with a tax bill. You can transfer it from trustee to trustee by submitting a form to the new bank or brokerage firm or you can have your financial institution handle the transfer directly.
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
If you have 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. 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.
10. Penalty-Free Emergency Withdrawals Are for Hardships Only
You can dip into your retirement funds early if you face a hardship, which must be considered an immediate and heavy financial need. If the need is deemed acceptable according to federal guidelines, you can withdraw only enough to cover the cost of the hardship, however, from your IRA.
11. Avoid Penalty by Using Funds for Medical Bills
If you make an early withdrawal to pay for unreimbursed medical expenses you won’t be penalized. Keep in mind, however, that you can do this only with medical expenses that exceed 7.5 percent of your adjusted gross income.
12. Receive Funds on a Regular Distribution Schedule
One way to avoid penalties is super easy. Simply choose to receive your withdrawals in periodic payments, and you’ll avoid an early withdrawal penalty.
13. No Penalty for Involuntary Distribution
Another way to avoid paying a penalty on early withdrawal is if the distribution is to pay for an IRS tax levy. Use IRS Form 5329 if you need to claim this penalty exception.
14. Reservist Distributions Are Penalty-Free
If you are a member of the National Guard or a reservist and you’re called to active duty for at least 180 days, you can make a penalty-free withdrawal. Note that there are some restrictions to this rule, so make sure you qualify before you act.
15. No Penalty If You Die
Your IRA account will avoid paying penalties for early withdrawals if you die. Should you pass away, your beneficiaries will not be subject to any withdrawal penalties.
16. No Roth IRA Penalty in the Case of a Disaster
If you withdraw cash from your Roth IRA early under a qualified disaster recovery assistance distribution, you won’t pay an early withdrawal penalty. To qualify for a qualified disaster recovery distribution your home must be in a Midwestern disaster area on an applicable disaster date and you must have sustained a monetary loss because of severe flooding, storms or tornadoes in the disaster.
17. Avoid a Penalty by Using Funds for Health Insurance Premiums
You can avoid a penalty if you withdraw your money to pay for health insurance premiums. You must be unemployed for at least 12 weeks to do this and you can deduct premiums for yourself, your spouse or your dependents.
Barri Segal contributed to the reporting for this article.