Rising living cost is taking its toll on the daily lives of ordinary Americans, but it could also be robbing them of their future.
A record number of people taking 401(k) “hardship withdrawals“.
According to a report from Allianz Life, 54% of Americans had reduced or stopped their contributions. 43%of respondents surveyed say they have dipped into a retirement account due to inflation pushing up the cost of living.
Your retirement savings are intended to support your lifestyle in later life. That’s why early withdrawals usually result in significant financial penalties.
Taking money out of your retirement account before the age of 59½, attracts a 10% tax penalty. In addition, there may be income taxes due as a result of the withdrawal.
Albeit, there are some situations in which account owners — both those with savings in individual retirement accounts and workplace plans like a 401(k) — can access that money early without penalty.
Here are some situations in which you won’t be charged a 10% early withdrawal penalty in case you need to access your retirement account.
10 Time You Won’t be Charged an Early Withdrawal Penalty for Withdrawing From Your IRA
1. Higher education expenses.
If IRA funds are used to cover certain higher education expenses for you, your spouse, your children, or your grandchildren, you may not be subject to the penalty.
Tuition, fees, books, materials, equipment needed for a student to enrol or attend, and charges for specific special needs services are all considered eligible costs. For kids who attend school at least half-time, room and board are also eligible.
Students must enroll in a college, university, vocational school, or other institution that is eligible to take part in student aid programs offered by the US Department of Education. According to the IRS, they include “nearly all” accredited public, nonprofit, and privately held for-profit institutions.
2. ‘First time’ home buyer.
Contrary to what the heading suggests, you don’t necessarily have to be first-time home buyers to benefit from this exception. A first-time buyer, according to the IRS, is someone who hasn’t purchased a property in the previous two years.
Such IRA owners may make penalty-free withdrawals up to $10,000. This amount is the maximum you can earn in a lifetime. However, this money has to be spent on what the IRS terms, “qualified acquisition costs” is required.
These include, “any typical or reasonable settlement, financing, or other closing fees,” as defined by the IRS, as well as the expenditures associated with purchasing, constructing, or rebuilding a property. Upon receipt of the funds, you have 120 days to spend them.
Apart from yourself, qualified family members such as your spouse and kids are eligible for this early withdrawal. If you and your spouse are both first-time homeowners, you may each withdraw up to $10,000 without incurring any penalties.
Penalty-free withdrawals for first-time home buyers apply to IRAs, but not 401(k)s or 403(b)s.
3. Health insurance if unemployed.
If you lost your employment, distributions used to pay health insurance premiums for you, your spouse, and any dependents would not be subject to an early withdrawal penalty.
To be eligible, you must have received unemployment benefits (via a federal or state program) for 12 straight weeks. The IRA withdrawal must also take place the same year you lost your job, if not the year after. Furthermore, you have 60 days after being hired again to take the withdrawal.
4. Death.
In general, beneficiaries who receive an IRA upon the owner’s passing are not penalized if they withdraw funds before turning age 59½.
5. Unreimbursed medical expenses.
A withdrawal to cover healthcare expenses may not be subject to penalty if your medical costs exceed 7.5% of your annual adjusted gross income (AGI). However, the withdrawal has to be in the same year that you incurred the medical expenses.
For instance, if your AGI is $100,000 in 2022, you can utilize a withdrawal to pay for medical expenditures that were not reimbursed that exceeded $7,500 in that year.
6. Birth or adoption.
Each parent’s separate retirement account may be used for a maximum of $5,000 per birth or adoption. The money would pay for related costs.
The withdrawal from the account must be done within a year of the birth of your kid or the day your child was legally adopted.
7. Disability.
Not all disabled retirement savers under the age of 59½ are exempt from the tax penalty if they make early withdrawals from their accounts.
According to the IRS, the person must be “totally and permanently handicapped” in order to be eligible for an early withdrawal.
This means that the person would be unable to engage in “any substantial gainful activity” due to a medical or mental condition. The ailment should be predicted to result in death or to be of lengthy, continuing and indefinite duration by physician.
Overall, it’s a strict standard that’s difficult to satisfy. In reality, the person must be either bedridden and unable to work or close to death.
8. IRS levy.
If a tax levy from the IRS causes the distribution, you won’t be penalized (i.e., if the IRS takes your retirement funds to satisfy a tax debt).
9. Active reservists.
Army, Navy, Marine Corps, Air Force, Coast Guard, and Public Health Service reservists are exempt from early withdrawal penalty.
In order to be eligible, you have to be called or ordered to active service after September 11, 2001, and they had to have served for 180 days or more.
Their accounts cannot be distributed sooner than the day of the active duty call, and they cannot be distributed later than the end of the active duty time.
10. Substantially equal periodic payments.
This exemption for early withdrawal from your IRA account is somewhat complicated and likely requires the help of an accountant or advisor.
Simply put, a taxpayer can prevent a fine by adhering to a formula that specifies the periodic account disbursements (at least one per year). These “substantially equal monthly payments,” usually referred to as 72(t) payments, are similar to annuities.
The saver must choose the appropriate withdrawal amount and follow the plan until they are 59½ years old, which, depending on the time frame, leaves plenty of opportunity for mistakes.
Making a mistake may be expensive. For instance, taking the incorrect amount one year would nullify the exemption, and the taxpayer would be responsible for the 10% penalty for each year that withdrawals had already been made.
Early Withdrawal Penalty: Final Thoughts
Withdrawing from your retirement account is not a good move.
It jeopardizes your future when you have to be living off the fruit of your labor. As such, doing so should only be considered as a last resort.
However, if you find yourself in such a situation, the tips outlined above can help you initiate a withdrawal without getting penalized by the IRS.
