How to Avoid a Tax Penalty from an Early IRA Withdrawal

The general rule is that tapping into your IRA for cash before age 60 means you will be taxed 10% for the early withdrawal. Most advisers tell you not to dip into your nest egg unless you have no other choice.

What are the exceptions that allow you without the 10% penalty?

  • If you lost your job and have collected 12 consecutive weeks, you can use your IRA for money at any age but only to pay for health insurance premiums. The question is how would the IRS know all of the money actually was used for this purpose?
  • You can withdraw money from your IRA before age 60 for qualified higher education expenses- such as, college or vocational tuition for yourself, spouse, your kids or your grandkids.
  • You can tap into your IRA for up to $20K (if married) to buy, build, or rebuild your first home, or your kids first home.
  • You can use your IRA to pay for reimbursed medical expenses that are greater than 10% of your adjusted gross income.
  • If you become disabled before age 60, you can also use your IRA without penalty.
  • You can avoid a penalty by withdrawing a series of payments of equal amounts over five years before age 60. Calculating what the correct amount to avoid the penalty is difficult, however. It based on the RMD.

What IRS publications can help?

  • IRS Publication 590
  • Form 5329

When a distribution-withdrawal occurs, your IRA sends you a 1099-R and to the IRS. They are coded indicating you took an early withdrawal. When filing the taxes, form 5329 must be used to indicate to the IRS which exception to tax penalty you are claiming. You may be asked for documentation to support your claim of early withdrawal.

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