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 plan.

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 the withdrawal, but in other situations, you may be exempt from these fees.

Accessing your money early can be a helpful feature for some people. But you should seriously consider the implications of your withdrawal before you choose to make this move because of the taxes, fees, and potential impact on your retirement savings.

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

Can You Withdraw Money from a Rollover IRA?

In short, 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 an IRA, you can withdraw IRA funds, but most often, you’ll be required to pay taxes on that money. This amount will be added to your income for the year and taxed accordingly at the state and federal levels.

Plus, if you’re younger than 59 1/2, you’ll owe an additional tax penalty in the form of a 10% early distribution fee.

But there are some exceptions to this rule. In some instances, the IRS allows you to withdraw funds without the 10% penalty, like when:

• You make a first-time home purchase (you can take up to $10,000 from your IRA).
• 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?

Fortunately, 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 or a SIMPLE IRA, the funds will be taxed as ordinary income for that tax year. The same rules don’t apply to a Roth IRA, where you have 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.

Typically, the IRS charges an additional 10% early distribution fee on IRA withdrawals if you’re under age 59 1/2; 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.

Here are some of those occasions.

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 distributions 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.

These conditions 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 in aggregate (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.

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 with different withdrawal rules, you may be wondering how to start the process and what to expect.

Make sure you have reviewed the IRA rules with a tax professional 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 you’ll have to pay income taxes.

If you have a Roth IRA and are over 59 1/2, your 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 Roth IRAs 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 withdrawals from a Roth IRA versus a Traditional IRA that applies to account holders after age 59 1/2. Traditional IRAs have Required Minimum Distributions (RMDs) beginning at age 73, and Roth IRAs have no RMDs. The IRS determines your RMD by considering your account balance in tandem with a life expectancy calculation.

Bottom Line

While it can be risky to withdraw from your IRA due to potential taxes, penalties, and disruptions in your investments, 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 complete a rollover IRA withdrawal without paying extra fees.

When making decisions about your retirement funds, it’s best to speak to a professional who can help you with investment advice.

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.