How to withdraw funds from your IRA penalty free

How to withdraw funds from your IRA penalty free is one of the most common questions we receive on a daily basis. But what is an IRA? An IRA or individual retirement account is a special custodial or trust account implemented through brokerage firms, banks, insurance companies, mutual funds, and various other financial institutions. In all cases, earnings accumulate within an IRA on a tax-deferred basis. In some cases, the amount of the individual’s contribution to an IRA is deductible from their current taxable income.

Not all IRA’s are created equally. Some provide greater benefits then others. Furthermore, the rules are extremely different from one IRA to another. Our primary focus will be on the most common. The traditional IRA and the Roth IRA. This post will teach you how to withdraw funds from your IRA penalty free.

Distributions and taxation

Distribution rules can be quite complex, yet it is essential that they are followed in order to avoid government penalties. Specifically, being penalized if distributions are taken before a certain age, if they do not begin by a certain age, and if distributions – once they have begun – are below a mandated minimum. We will examine each of these scenarios.

Taking distributions too early

Distributions from employer-qualified plans and or IRA’s are taxed as ordinary income and are charged a 10% early distribution penalty if they are taken before age 59 1/2. There are, however, some exceptions. The following exceptions apply specifically to IRA’s.

The standard IRA 10% penalty exceptions

Withdrawals used for first-time homebuyer expenses ($10,000 lifetime cap). When the funds are used by a first-time homebuyer. Distributions up to $10,000 taken for qualified first-time homebuyer expenses are not subject to the 10% penalty. To qualify, the amount must be used within 120 days to pay the qualified acquisition costs of the first-time homebuyer. Generally, these are the costs of financing, settlement, or closing related to buying, building, or reconstructing a personal residence. To qualify as a first-time homebuyer, the taxpayer and spouse must not have had an ownership interest in a principal residence for a two year period prior to the date of purchase or commencement of construction.

Withdrawals used for qualified higher education expenses (tuition, fees, books, and supplies required for attendance). Withdrawals used to pay health insurance premiums for qualifying unemployed individuals.

The complete list of IRA 10% penalty exceptions

due to the death of an IRA owner (such as distributions that are paid to the deceased owner’s estate or beneficiary)
due to permanent disability. The IRS’s definition of a disabled person is strict. An individual is considered disabled only if they are unable to engage in any substantial gainful activity by reason of a medical impairment that is of indefinite duration or is expected to be long term or to result in death.
that are part of a series of substantially equal periodic payments made over the owner’s life expectancy or the joint life expectancy of the owner and the beneficiary of the IRA.
to the extent that they are used to pay unreimbursed medical expenses exceeding 7.5% of the individual’s adjusted gross income.
to the extent that withdrawals do not exceed the amount paid for medical insurance premiums (for the IRA owner and their spouse dependents)
qualified disaster distributions up to a $100,000 cumulative lifetime limit.