Even the best-laid retirement plans can hit a snag, be it from a prolonged illness, a lengthy bout of unemployment or merely a crop of unforeseen expenses. While investments made in to an IRA are intended to remain in the account until you reach the age at least 59 1/2, sometimes investors must tap their retirement funds early. In most circumstances, you'll face excise taxes as a penalty for premature distribution, although the Internal Revenue Service (IRS) allows a few exceptions to its early-distribution penalty.
Early Distribution Penalties
Although it's not advisable, you can withdraw money from an IRA at any point so long as you pay the taxes associated with the early withdrawal. The IRS subjects all money you withdraw from an IRA before you reach the qualifying age of 59 1/2 to an early-withdrawal excise tax of 10 percent as of the time of publication. In addition to the penalty, you must report funds withdrawn as income for the tax year in which you withdrew them. Because of this, an investor in the 25-percent tax bracket who receives a premature distribution should expect to lose 35 percent of the lump sum withdrawn to taxes. Distributions of larger amounts, or by investors in higher tax brackets, incur higher taxes, which may be up to 45 percent for taxpayers who earn $379,150 or more as of the time of publication.
Hardship Exemptions to Early Distribution Penalties
The IRS allows you to make penalty-free withdrawals from your IRA in times of hardship. To qualify for a hardship distribution, you must demonstrate you're using the funds to pay for secondary education, either yours, a child or a grandchild's, or incur medical bills that exceed 7.5 of your adjusted gross income. If you receive unemployment insurance benefits for 12 or more weeks, you may take a penalty-free distribution to cover healthcare expenses. First-time homebuyers are also allowed to withdraw up to $10,000 without incurring the excise tax.
Annuitized Early Distributions
The IRS allows investors to annuitize their IRA holdings at any time and avoid the penalty. Using this method, known as rule 72(t), you and an accountant determine your remaining life expectancy based on the IRS actuarial tables. After determining your projected lifespan, you're allowed a penalty-free withdrawal equal to a proportion of the IRA's balance for each year you're projected to live. For example, if you're projected to live 10 more years, you may annuitize 10 percent of your IRA each year. If you choose to annuitize your IRA, you must take distributions for at least five years, or until you reach retirement age, whichever comes first.
Death and Disability
The IRS also allows you to take IRA distributions early without incurring 10 percent excise tax penalty if you become disable and are unable to work. Additionally, if you die before you reach retirement age, the person named as beneficiary of your IRA may immediately access the funds without triggering the excise tax.
- IRS.gov: Publication 590 - Traditional IRAs
- Bankrate.com; IRS Rules for Early IRA Withdrawals; Kay Bell; March 2008
- Smart Money; Tapping Your IRA Penalty Free; July 2010
- IRS.gov: Retirement Plans FAQs Regarding Substantially Equal Periodic Payments
- CNN Money; Freeing Up Money During Tough Times; Walter Updegrave; May 2009
- medical image by mario beauregard from Fotolia.com