What are the exceptions for IRA early withdrawal penalty?

When you make contributions to your IRA account, you expect these retirement savings to help you in retirement. However, there are instances when you may be forced to take a distribution before reaching the required retirement age. When this happens, you could trigger a 10% early distribution penalty tax. Luckily, there are situations when you may qualify for an exemption from the IRA early withdrawal penalty.

You may be exempted from the IRA early withdrawal penalty if you are withdrawing money to pay qualified medical expenses, pay health insurance if you are unemployed, pay qualified education expenses, fulfill an IRS levy, or because you are disabled and unable to work. If you are buying your first home, you may also be exempted from paying the 10% early withdrawal penalty up to $10,000. You still have to pay the income tax for the early withdrawal regardless of whether you pay the penalty or not.

Exceptions for IRA Early Withdrawal Penalty

Generally, you can expect to pay a 10% penalty tax when you take an early withdrawal from your IRA account. However, there are certain situations when you can take penalty-free withdrawals even if you have not attained the required retirement age.

Here are some of the instances when you can take an early withdrawal from your IRA without being penalized:

Medical expenses

If you have out-of-pocket medical costs that are not covered by your insurance, you may qualify for a penalty-free withdrawal from your IRA to meet your expenses. The exemption applies if you incur medical costs that are above 7.5% of your adjusted gross income. You must incur the medical costs in the same year you took a distribution from your IRA.

Health insurance

If you are unemployed, you may be allowed to take a penalty-free distribution to pay your medical insurance premiums. You may be exempted from the penalty tax if you meet these requirements:

To be eligible for this exemption, you must meet these requirements:

• You lost your job
• You collected unemployment checks for 12 continuous weeks.
• You made the early withdrawal in the year you received unemployment checks or the next year.  
• You received the distribution within 60-days of re-deployment.

Permanent Disability

If you become permanently disabled, and you cannot perform any substantial gainful activity due to the condition, you may be allowed to take a distribution without paying the 10% penalty. You may be required to provide documentation to prove that you suffered a mental or physical disability before you can make a penalty-free withdrawal. You may be required to go through a physical checkup by a qualified physician to determine the severity of the disability and to confirm that the condition is likely to be prolonged, and could result in death.

First-time home purchase

The IRS allows account holders to withdraw up to $10,000 from an IRA to buy or build their first home without owing the 10% early withdrawal penalty. If you are married, your spouse can also withdraw up to $10,000 from their IRA account, bringing the total to $20,000. To qualify for the exemption, you must be a first-home home buyer. The amount withdrawn must be used to pay for home purchase associated costs within 120 days after receipt of the money.

This exemption may also apply if you are withdrawing money to build or purchase a home for a grandparent, parent, spouse, your spouse’s child, your child, or your grandchild,

Qualified Higher Education Expenses

If you take an early IRA withdrawal to pay qualified education expenses for your spouse, child, or yourself, you may qualify for the 10% penalty exemption. Qualified education expenses include room and board, tuition, books, supplies, and education equipment required when enrolling in college. You can pay education expenses for students enrolled in college, university, or a vocational school that is eligible to receive federal student aid.

Inherited IRA

If you inherited an IRA from a parent or spouse before age 59 ½, you can take a penalty-free distribution from the account. The exemption may not apply if you inherit the IRA and rollover the funds into your own IRA. In this case, the IRS treats the inherited IRA as your own, and you will be required to pay taxes and a 10% penalty on any distributions you take before age 59 ½.

If you are a non-spouse beneficiary and the account owner died after 2020, you will be required to take penalty-free distributions from the inherited IRA within 10 years. However, the 10-year rule does not apply if you are the spouse, a minor, or a child who is disabled or chronically ill.

Fulfill an IRS Levy

If you owe federal taxes, the IRS may withdraw an amount equivalent to the owed federal taxes from your IRA. You are exempted from paying an early withdrawal penalty if the IRS draws the money directly from the account.

Substantially Equal Periodic Payment (SEPP)

The IRS allows retirement savers to withdraw money penalty-free from the IRA for five years if they meet certain requirements. Usually, if your request is approved, you will receive a yearly payment for five years, or until you reach age 59 ½, whichever comes first. If you don't stick with the withdrawal schedule, you won't get an exemption on the early withdrawal penalty. To know how much you qualify to take as SEPP, you can use one of the three approved IRS methods.