Penalty Free IRA Withdrawals

Back in the early 1980s the Individual Retirement Arrangement (“IRA”) became a popular vehicle for individual workers to sock away up to $2,000 annually (the limit is now $3,000, soon to go up to $4,000) without current taxation. Earnings on these contributions would also accumulate on a compounded basis without current taxation. IRA contributions and earnings are taxed at the time of retirement, usually at a lower tax rate.

The major catch to IRA accounts is the 10% penalty applicable to early withdrawals, generally for funds withdrawn before age 59. As account balances grew, many people were tempted to withdraw IRA funds for non-retirement purposes, triggering the 10% penalty, as well as current taxation on the amount of the withdrawal.

The Internal Revenue Code has since been amended to allow certain penalty free withdrawals under specified circumstances. These include:

  • Unreimbursed medical expenses that exceed 7.5% of income, sometimes referred to as extraordinary medical expenses.
  • College tuition for the taxpayer, a spouse, child or grandchild.
  • Up to $10,000 for a first home purchase.
  • Certain other expenses, subject to limitations based upon life expectancy.

Even though the IRS has relaxed the restrictions on use of IRA funds before retirement, you should still think long and hard before doing so. When it comes to retirement planning, we recommend that you err on the side of being conservative. If at all possible, try to obtain necessary funds from other sources before tapping that retirement account. It should be a last resort.

— Kevin Palmer

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