By Andy Ives, CFP®, AIF®
For IRA owners and retirement plan participants who are under age 59 ½, taking a distribution from a retirement account is typically off limits. The distribution will most likely be taxable, and there is a good chance that a 10% penalty will also apply. However, sometimes life gets in the way and a withdrawal needs to be made.
Before shaking out your retirement piggy bank, know the rules. There is a possibility that the 10% penalty can be avoided. The IRS provides some exceptions, but be careful. Some of the exception apply only to IRAs, some apply only to plans, and some apply to both.
Exceptions Applicable to Both IRAs and Plans (Including SEP and SIMPLE IRAs)
- 72(t) “substantially equal periodic payments”
- Medical expenses (over 7.5% of AGI)
- IRS levy
- Active reservists
- Birth or adoption
Exceptions Applicable to IRAs Only (Including SEP and SIMPLE IRAs)
- Higher education expenses
- First-time home buyer
- Health insurance if you are unemployed
Exceptions Applicable to Plans Only (Excluding SEP and SIMPLE IRAs)
- Age 55
- Age 50 for public safety employees
- Section 457(b) (governmental) plans
- Divorce (QDRO – qualified domestic relations order)
- Phased retirement distributions from federal plans
Additionally, some of the exceptions apply only to the account owner. For example, the disability exception can only be used if the IRA or retirement plan participant is the one who is disabled. If an under-59 ½ spouse were to take an IRA distribution from his own account under the impression that he could claim the disability exception based on his wife’s disability, he would be mistaken. The 10% penalty would apply.
On the flip side, some exceptions are available to the account owner as well as certain family members. The higher education exception is a good example. As long as the higher education expenses are for the IRA owner, the IRA owner’s spouse, or any child or grandchild of the IRA owner or the IRA owner’s spouse, then the 10% penalty exception will work.
There is definitive nuance to each of the 10% penalty exceptions. The timing of the distribution vs. when bills are paid can be critical. Some exceptions allow for repayment, others do not. Regardless of which exception is applicable to your situation, be sure to know the rules before taking any plan or IRA distribution.