IRA Withdrawal Rules - What You Need to Know

In an ideal world, we would all leave our IRA contributions untouched in our retirement savings account so they can grow over time. But life can be unpredictable and unexpected circumstances may affect your retirement plans.

While many types of retirement funds or investments may not have any option to withdraw your money early, an IRA could give you the option to withdraw funds, even if you’re younger than 59 1/2. Usually, you’ll owe income tax and additional taxes on a traditional IRA withdrawal, but in other situations, you may be exempt from these fees.

Accessing your money early can be helpful for some people. But you should seriously consider the implications of making a withdrawal from your individual retirement account, since it does come with costs.

This article will discuss everything you need to know about IRA withdrawal rules, including when it’s possible, what the penalties are, and when you can avoid those fees.

Can You Withdraw Money from a Rollover IRA?

Short answer: yes, you can withdraw your retirement savings from a rollover IRA in many circumstances. However, this withdrawal may not be penalty-free.

If you’ve rolled over your 401(k) into a traditional IRA, you’ll be subject to traditional IRA withdrawal rules. That means the entire amount will be taxed at your regular tax rate, and add to your total taxable income for the year.

Plus, if you’re younger than age 59½, you’ll owe an additional tax penalty in the form of a 10% early distribution fee.

Fortunately, there are a few exceptions to this rule. where the IRS allows you to make qualified distributions without the 10% penalty:

• You make a first-time home purchase (you can take up to $10,000 from your IRA as part of the first-time homebuyer exception).
• You give birth or have adoption expenses (you can take up to $5,000 from your IRA).
• You have qualified higher education expenses.
• You have out-of-pocket medical expenses that exceed 10% of your adjusted gross income.
• You’re unemployed and need to pay for health insurance (you’ll have to prove you meet specific qualifications).
• You become disabled (or you pass away, and your beneficiaries can withdraw the funds).

Note that if you’re working with a tax-deferred account, you’ll escape the early withdrawal fee but will still have to pay ordinary income tax — even if you fall under one of the above exceptions.

Can Early Withdrawal Penalties Be Avoided?

The 10% early withdrawal penalty can be avoided in some situations when you take money out of your IRA and you’re under the age of 59 1/2.

If you withdraw from a pre-tax IRA, like a traditional IRA, a SEP IRA or a SIMPLE IRA, the funds will be taxed as ordinary income for that tax year, both federal taxes and state taxes. The same rules don’t apply to a Roth IRA, where you have already paid taxes on the funds before investing. You may, however, have to pay taxes on the earnings portion of your Roth IRA if you’ve had the account open for less than five years and/or if you’re under age 59 1/2.

Along with the 10% early distribution fee on IRA withdrawals, a state tax penalty may also apply. But as we mentioned above, some scenarios are treated as an exception, and you’re allowed to make penalty-free withdrawals. The money will still count toward your taxable income, however.

Higher Education Expenses

If you use your IRA withdrawal to pay qualified higher education expenses for yourself, your spouse, or your child, you can avoid the 10% early withdrawal penalty. The IRS explains these qualified expenses, but in short, they include tuition, books, or supplies needed to attend a college or university. There is also a calculation that limits how much you can withdraw in a way that’s exempt from the 10% fee.

Pay Overdue Health Insurance Premiums

When you’re unemployed, you’re allowed to take hardship withdrawals to pay for your health insurance premiums without a penalty. You’ll need to meet all of the specified criteria below (and be able to show proof) to avoid the tax penalty.

Conditions of such hardship withdrawals include:

• Losing your job.
• Receiving unemployment for 12 weeks in a row.
• Withdrawing the IRA funds during the year when you were unemployed or the following year.
• Receiving the distributions no later than 60 days after you’ve been re-employed.

Unreimbursed Medical Expenses

Taxpayers with out-of-pocket medical expenses (not covered by insurance) can sometimes take IRA distributions penalty-free. There are two conditions you must meet:

1. These medical expenses must be more than 10% of your Adjusted Gross Income (AGI); and
2. You must pay these medical expenses in the same year as the withdrawal.

First-time home buyers

If you’re buying, building, or rebuilding a house for the first time, you can take up to $10,000 from your IRA without penalty —and your partner can also take $10,000 from theirs.

This is a lifetime limit, so you wouldn’t be able to take out more than $10,000 total (without penalty) over the course of your life.

A first-time home purchase, in this context, means you haven’t owned a principal residence in the last two years. So you could, in theory, use the exemption multiple times—but you’d still need to keep total withdrawals under $10,000 from a lifetime perspective.

Finally, you don’t even have to be the homebuyer in this scenario, either. You can take a penalty-free IRA distribution if you’re helping your spouse, child, grandchild, or parent with their home purchase.

Reservist Distributions

When called to active duty, qualified reservists (members of the military service who are not active) are allowed to make early distributions from their IRA without the 10% penalty.

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What You Can Expect When Initiating a Withdrawal

If you need to borrow from your retirement account balance for any reason, including one of the situations we discussed above, you may be wondering how to start the process and what to expect.

For starters, make sure you have reviewed the IRA rules with a tax advisor before beginning to process to understand if your distribution is eligible to be tax-free and/or penalty-free.

If you do proceed, these are the steps you can take to be prepared when you initiate an early withdrawal from your tax-deferred IRA account.

First, as the IRA owner, you’ll be asked to specify three key details:

1. How much are you looking to withdraw? Identify the exact amount you’ll need to take out of your account.
2. What federal and state taxes do you want to have withheld? You can choose a percentage, if any, to avoid owing extra money at the end of the year when you file your tax return.
3. What withdrawal frequency do you want? Are you looking to take out a one-time lump sum, or are you looking to set up a Substantially Equal Periodic Payment (SEPP)?

Then, you’ll have to choose the method by which you’ll receive the funds from the following options:

• Electronic funds transfer (EFT) or bank wire where the money is directly deposited into your bank.
• A paper check made out to you and sent in the mail.

Are There Penalties for Withdrawing from Your IRA Over the Age of 59 1/2?

Once you’re over 59 1/2, you won’t face the extra 10% penalty on your IRA distributions because they won’t be considered early distributions. But traditional IRA withdrawal rules state you’ll have to pay income taxes.

For Roth IRA owners over 59 1/2, your Roth IRA withdrawals are entirely tax-free and penalty-free since you paid income taxes on the funds before you invested them with your brokerage. This applies to any Roth IRA withdrawal as long as the account has been open for at least five tax years according to the “5-Year Rule.”

Keep in mind another key difference between a Roth IRA withdrawal versus a Traditional IRA withdrawal, even after age 59 1/2. Traditional IRAs have Required Minimum Distributions (RMDs) beginning at age 73, and Roth IRAs have no RMDs. That means Roth IRA earnings can continue to grow indefinitely over the life of the original account owner.

Bottom Line

While it can be risky to withdraw from your individual retirement accounts due to potential taxes, penalties, and disruptions to your retirement plans, there are circumstances when penalties can be avoided.

If you’re buying a home for the first time, paying back medical expenses, or finding yourself in other specific circumstances, you may be able to make an IRA withdrawal without paying extra fees, whether it’s a self-directed IRA, SEP IRA, SIMPLE IRA or Roth.

When making decisions about your retirement funds, it’s best to speak to a professional who can help you with investment advice and keep you abreast of regulations like contribution limits.

Capitalize can be a trusted partner to manage a rollover of your retirement funds. Explore how we can help you with your future savings today.