You know that withdrawing funds from your traditional IRA before you turn 59 1/2 usually means a tax hit. But how much you'll pay in taxes, or even whether you'll face any tax penalty at all, depends on a host of factors.
If you withdraw funds from your traditional IRA before you turn 59 1/2, you'll face a double tax hit: You'll have to pay taxes on your withdrawal according to your income-tax bracket, and you'll face an early-withdrawal penalty of 10 percent on the money you withdraw. That can add up to a significant amount of money. If you withdraw $20,000 from your IRA before you hit 59 1/2, and you're at the 28 percent income-tax bracket, you'll pay taxes of $5,600. You'll also face a 10 percent early-withdrawal penalty of $2,000. That comes out to a total tax bill of $7,600.
There are cases, though, in which you can withdraw money early from an IRA without paying any early-withdrawal penalty at all. You can withdraw up to $10,000 from an IRA penalty-free if you use that money to purchase a first home. Married first-time buyers can withdraw up to $20,000 from IRAs without being penalized. The IRS defines first-time buyer rather unusually: You qualify as a first-time buyer if you haven't owned a principal residence any time during the last two years. This means that you can actually be buying a second or third home and still be considered a first-time buyer.
The government also provides a penalty-free exception if you withdraw funds from an IRA early to pay for your higher education. You can also withdraw money early to pay for the higher-education costs of your spouse, children or grandchildren. You must make sure, though, that you use your IRA funds to pay for a college, vocational school or university that is accredited. You can use your IRA dollars to pay for tuition, books, room and board and other equipment.
Exceptions Don't Eliminate Taxes
Be careful, though. While the housing and higher-education exceptions for early withdrawals do eliminate the 10 percent early-withdrawal penalty, they don't erase your tax obligations. You'll still have to pay taxes at your normal tax rate on the dollars that you withdraw from your traditional IRA, even when you withdraw those dollars to buy a first house or pay your college tuition.