There are a number of ways to avoid the IRS ten-percent tax penalty for early withdrawal (usually before age 59 and a half). They have to do with IRS rules and apply mostly to what are called “Non-Financial Hardships.” If you meet the following criteria, you can withdraw funds from your regular or Roth IRAs or your IRA 401K account and avoid the tax penalty:
♦ For traditional and Roth IRAs:
1. You rollover your IRA to a new account.
2. You rolled over a lump-sum payment from a previously cashed-in IRA and your opened the new account within 60 days.
3. You were disabled (permanently and totally).
4. You were out of a job and paid for health insurance premiums.
5. You had college expenses.
6. You purchased a house.
7. Your medical debts are more than 7.5 percent of your adjusted gross income.
8. The IRS claimed money from your retirement account because you owed back taxes.
♦ For qualified retirement plans such as a 401K:
1. Your medical debts are more than 7.5 percent of your adjusted gross income
2. You were disabled (permanently and totally).
3. You are laid off permanently, fired, quit, or take early retirement in the same year of your 55th birthday or later.
4. You are laid off permanently, fired, quite, or retired and work out a payment schedule of regular withdrawals for the same amount for the rest of your life. You must continue to accept those equal payments for at least five years or until you reach age 59 and a half, whichever period is longer.
5. You receive a court order requiring support payment to your divorced spouse or dependent.
→ A word of caution to those who own a so-called “Simple IRA account”: If you withdraw funds from a IRA and you first opened that plan during the past two years, your IRS tax penalty is 25% instead of 10%!
Note: All IRA withdrawals are still taxable. Whatever funds you take out of your IRA account, you’ll have to declare as income.
♦ Advice against IRA early withdrawals
Investment advisors unanimously agree that cashing in an IRA fund is generally unwise and shortsighted. Here’s some advice from Moolanomy.com on the subject:
“As tempting as it is to withdraw money from your 401k, it is important to take a step back and consider your options. A hardship withdrawal doesn’t have to be paid back, but you are missing out on opportunities when you remove that money. It is gone from your account, and you can no longer count on it to work on your behalf, building up wealth.”
♦ Borrowing from your 401K plan
IRS regulations permit borrowing plans for loans to be taken from an IRA account. You cannot take the loan directly from your IRA account, and not all employers offer the borrowing option. And here is a kicker, according to the IRS:
“If the owner of an IRA borrows from the IRA, the IRA is no longer an IRA, and the value of the entire IRA is included in the owner’s income. (Code § 408(e)(2) and (3)).”
For an interesting take on using the “rollover loophole” and borrowing against your IRA see the Productivity 501 web page, “Borrow from your IRA.”