Now that you're properly chastised, if you do need to take a withdrawal, some hardship situations qualify for a penalty exemption from an IRA or a 401(k) plan.
Note that penalty-free does not mean tax-free. All traditional IRA and 401(k) withdrawals require that you pay taxes at ordinary income rates. Contributions to a Roth IRA can be taken out at any time, and its earnings may be withdrawn penalty and tax-free after five years. The same rules apply to a Roth 401(k), but only if the employer plan permits.
In certain situations, a traditional IRA offers penalty-free withdrawals even when an employer-sponsored plan does not. We explain those situations below. Also, be aware that employer plans don't have to provide for hardship withdrawals at all. Many do, but they may permit hardship withdrawals only in certain situations -- for instance, for medical or funeral expenses, but not for housing or education purposes.
These circumstances qualify for IRS-sanctioned, penalty-free hardship withdrawals.
Unreimbursed medical bills
The government will allow investors to withdraw money from their qualified retirement plan to pay for deductible medical expenses, "to the extent that the unreimbursed medical bills exceed 7.5 percent of the person's adjusted gross income," says Alan Rothstein, a CPA at Rothstein & Co., in Avon, Conn.
The withdrawal must be made in the same year that the medical bills were incurred, says Rothstein.
You do not have to itemize deductions to take advantage of this exception to the 10 percent penalty, according to IRS Publication 590.
The IRS dictates that investors must be totally and permanently disabled before they can dip into their retirement plans without paying a 10 percent penalty.
Rothstein says the easiest way to prove disability to the IRS is by collecting disability payments from an insurance company or from Social Security.
"That is excellent proof that you are disabled, if you're getting benefits from the government and from a private insurance carrier," he says.