Premature Withdrawals

There are a number of rules limiting the withdrawal and use of your IRA assets. Violation of the rules generally results in taxation of the withdrawn amount as ordinary income plus a penalty equal to 10 percent of the withdrawal. The rules apply equally to SEP-IRAs and IRAs established under SIMPLE plans, except that the penalty for a withdrawal from a SIMPLE plan within the first two years of participation is 25 percent. Also, there are more lenient rules for Roth IRAs.

Generally, you violate the rules if you withdraw assets from your regular IRA before you reach the age of 59-1/2. However, there are a number of exceptions to these rules for cases that might be considered hardship withdrawals. If you can use any of these exceptions, you won't have to pay the penalty, but you will still be taxed at ordinary rates on the amount of the withdrawal. Also, you must complete IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, and give the reason that the distribution is escaping from the penalty.

Exceptions. There are several exceptions to the age 59-1/2 rule that can save you from having to pay the penalty. (You will still owe the income tax.) You can avoid the penalty in the following circumstances:

• You have unreimbursed medical expenses that are more than 10 percent (7.5 percent if you, or your spouse, are age 65 or over) of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance for you, your spouse and your dependents and all the following apply: (1) you lost your job; (2) you received unemployment compensation for at least 12 weeks; (3) you received the distributions in the year you received unemployment compensation or in the following year and you received the distributions no later than 60 days after you are re-employed.
• You are disabled and can provide a physician's statement as proof that you are unable to be gainfully employed and that the condition is likely to be either long-lasting or end in death.
• You are the beneficiary of a deceased IRA owner.
• You are receiving distributions in the form of an annuity - which means you are receiving substantially equally payments at least once a year for the remainder of your life (or life expectancy).
• The distributions do not exceed the amount of your qualified higher education expenses (such as tuition, books, room and board (for full-time students) at a post-secondary school for you, your spouse, your children and grandchildren (or those of your spouse).
• You use the distributions to buy, build, or rebuild home for you, your spouse, your (or your spouse's) children, grandchildren, parents or grandparent. This must be a first home or your (and if you are married, your spouse's) first home within the past two years. The amount that can be distributed penalty free is limited to $10,000.
• The distribution is due to an IRS levy of the qualified plan.
• You are a "qualified reservist," which means that you are a member of the reserves of a military branch and you were called to active duty after September 11, 2001 for more than 179 days and the distribution was while you were on active duty.

If none of these exceptions apply, you may still may be able to avoid the penalty. If you make a contribution to an IRA (perhaps mistakenly), you take no deduction for it, and you withdraw your contribution and pay interest before the due date (including extensions) of your income tax return for that year, the withdrawal is not a taxable distribution. However, any interest or income on the amounts are treated as taxable income in the year the contribution was made. The income must be reported on Form 5329.

© 2024 Wolters Kluwer. All Rights Reserved.