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Retirement accounts are meant to fund your lifestyle in later years — and raiding them early generally comes with a stiff financial penalty.
But there are some situations in which account owners — both those with savings in individual retirement accounts and workplace plans like a 401(k) — can access that money early without penalty.
Not that they should necessarily do so.
“The worst thing you can do is take from your retirement account before its intended purpose, because then what will be for your retirement?” said Ed Slott, a certified public accountant and IRA expert based in Rockville Centre, New York. “I would only do this if it was the last resort and this was the only money you had.”
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Savers generally incur a 10% tax penalty if they withdraw money from a retirement account before age 59½. This is on top of any income taxes resulting from the withdrawal.
The list below outlines situations in which IRA owners wouldn’t owe the 10% early withdrawal penalty.
Congress may soon add more. A $1.7 trillion legislative package to fund the federal government for the 2023 fiscal year contains a slew of retirement provisions, collectively named “Secure 2.0.” The measure, expected to pass within days, would add exceptions to the early-withdrawal penalty for IRA owners in cases of domestic abuse and terminal illness, for example.
Here are the current exceptions for those under 59½.
(Note: The first three apply only to IRAs. The others may apply to both IRAs and workplace retirement plans.)
1. Higher education expenses
You may be exempt from the penalty if IRA funds are used to pay qualifying higher-education costs for you, your spouse, or children or grandchildren of you or your spouse.
Eligible costs include tuition, fees, books, supplies, equipment required for a student’s enrollment or attendance and expenses for certain special-needs services. Room and board also qualify for students who attend school at least half-time.
Students must attend a college, university, vocational school or other institution that can participate in U.S. Department of Education student aid programs. (They include “virtually all” accredited, public, nonprofit, and privately owned for-profit institutions, according to the IRS.)
2. ‘First time’ home buyer
Contrary to what the IRS title might suggest, IRA owners don’t necessarily have to be first-time home buyers to avail themselves of this exception. The IRS generally defines a first-time buyer as someone who hasn’t owned a home in the last two years.
Such IRA owners can withdraw up to $10,000 penalty-free. This dollar threshold is a lifetime maximum.
The funds must be used for “qualified acquisition costs.” These are: the costs of buying, building or rebuilding a home, and “any usual or reasonable settlement, financing, or other closing costs,” according to the IRS. The money must be used within 120 days of receipt.
The IRA withdrawal can be used for you, a spouse or your child, among other qualifying family members. If both you and your spouse are first-time homebuyers, each can take distributions up to $10,000 without penalty.
The two-year-limitation period starts on the “date of acquisition”: the day on which you enter into a binding contract to buy, or on which the building or rebuilding begins.
3. Health insurance if unemployed
Distributions to cover health insurance premiums for you, a spouse and dependents may not be subject to a penalty if you lost your job.
To qualify, you must have received unemployment compensation (via a federal or state program) for 12 consecutive weeks. The IRA withdrawal must also occur the year you received unemployment, or in the following year. Further, you must take the withdrawal within 60 days of being reemployed.
4. Death
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Beneficiaries who inherit an IRA upon the owner’s death generally aren’t subject to a penalty if they pull money from the inherited account before age 59½.
5. Unreimbursed medical expenses
A distribution to cover medical costs may not be subject to penalty.
The exception applies to unreimbursed medical expenses that exceed 7.5% of your annual adjusted gross income. The applicable income is that during the year of withdrawal.
For example, if your AGI is $100,000 in 2022, you can use a withdrawal this year to cover unreimbursed medical expenses over $7,500.
You don’t need to itemize tax deductions to get this benefit. (In other words, you can still get it if you take the standard deduction.)
Slott cautioned against one end-of-year snag. If you put a medical bill on your credit card this week or next, that medical expense would count for the 2022 tax year — even if the credit-card bill itself isn’t paid until 2023.
That means an IRA withdrawal linked to that medical expense would have to occur in 2022, not 2023, to get the tax benefit.
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