Posted by Fred Lake

How to Avoid Early Retirement Withdrawal Tax Penalties

How to Avoid Early Retirement Withdrawal Tax Penalties

It is essential to make monetary preparation for your retirement. This explains the reason for a retirement account and why there are penalties when you withdraw early from such an account.

There is a penalty of extra tax deduction when you withdraw early from your retirement account. There are, however, exceptions to this. This exception does apply to employer-sponsored qualified plans or individual retirement. You might transfer some part of your firm's retirement plan to your IRA to enjoy these exceptions.

Here are the strategies:

  • Disability

Disability is one of the things that qualify you for early withdrawal from your tax account. There is, however, a clause. According to the IRS, for you to be eligible for this exemption, your disability must be "total and permanent."

In other words, you are indeed disabled if you cannot engage in any substantial activity due to mental or physical disability. Besides that, a physician must certify the disability. In other cases, the disability should last for 12 months at least.

  • Education (IRAs)

Any student engaged in a half or full-time academic work at a qualified academic institution can enjoy distribution from the IRA account to pay for qualified expenses. Examples of eligible expenses are books, tuition, and other supplies for your education. 

These expenses can be for anyone provided the person is a relative. Bear in mind, however, that if you pay for expenses with other government program funds, it might not qualify for this exemption. 

  • First-time homebuyers (IRAs only)

If you use the proceeds from your retirement account to build a house in four months, you can enjoy a penalty-free deduction. The home can be for you or anyone related to you.

According to the IRS, anyone can be a first time home buyer provided they are not part of the primary owners of a residence in the past two years. With this in mind, even if you had a house and sold it over two years ago, you can be considered a first-time homebuyer.

  • Unreimbursed Medical Expenses

According to line 37 of Form 1040, any medical expenses that are more than 10% of your adjusted gross income that is not reimbursed can be footed with funds from your retirement account. To, however, qualify for tax-free, the medical expenses, and the withdrawal must be in the same year.

  • Medical insurance during unemployment (IRAs only)

For people that lose their job and get unemployment compensation for 12 weeks consecutively, they can pay their med insurance premiums with funds from their retirement account. You can use funds from your IRA withdrawals for your payment or that of your family member, and you will not incur the 10% penalty.

The clause to this, however, is that you must make the withdrawal the year you got the unemployment compensation or the following year. 

  • Active Duty Military Reservist

For folks called to active duty for at least six months or members of the military reserves, they can also enjoy a tax-free withdrawal. This, however, applies to withdrawals made when you are actively in service.

  • Substantially equal periodic payments

There are times one might not meet any of the qualifying criteria above. However, if you want access to your retirement account without penalty, there is a way around it. You can have this by taking "Substantially Equal Periodic Payments." You can, however, take anyone longer – either five years or till you reach age 59 ½.

The IRS has some actuarial rules for calculating the "Substantially Equal Periodic Payments." You can neither start nor stop this payment once it commences. If you do, you will be charged the 10% early distribution tax, which will make you liable to the interest as well.

Concluding Remarks

You need to examine the pros and cons of taking from your retirement funds if you have any pressing expenses not related to retirement. If it is possible, be sure to look for other ways to address the needs. You could consider taking out a loan, and with a good credit score, you stand a better chance.

Fred Lake
Contact This Member