When you can tap your IRA and avoid a tax penalty

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You’ve been doing a great job of putting money away in an IRA for your retirement, but now you feel you need to raid your account to help with bills staring you in the face today. Can you pull out some cash without taking a financial hit?

Sometimes, yes.

IRA withdrawals made before you reach age 59 1/2 are generally considered by the IRS to be premature distributions. You usually owe any tax that might be due on the money, plus a 10 percent penalty on the amount.

Your home equity may be a better source of cash than your IRA. Still, there are times when the IRS says it’s OK to use your retirement savings early.

In these cases, you’ll avoid the typical early withdrawal penalties. However, you’ll still owe any taxes due on the money you take out.

OK for school

The IRS says no penalty will be assessed as long as you’re taking out IRA money for qualified education costs for yourself, your spouse or your children or grandkids.

You must make sure the eligible student attends an IRS-approved institution. This is any college, university, vocational school or other postsecondary facility that meets federal student aid program requirements. The school can be public, private or nonprofit as long as it is accredited.

The retirement funds can be used to pay tuition and fees and buy books, supplies and other required equipment.

Expenses for special-needs students also count. And if the student is enrolled at least half time, room and board also meet IRS expense muster.

First-home exemption

Uncle Sam will bend the IRA rules a bit to help you become a homeowner.

You can put up to $10,000 of IRA funds when you want to buy your first home. If you’re married, and you and your spouse are first-time buyers, you each can pull from retirement accounts, giving you $20,000 in residential cash.

Technically, you don’t have to be purchasing your very first home. You qualify under the tax rules as long as you (or your spouse) didn’t own a principal residence at any time during the previous two years.

You can even share your IRA wealth. The IRS says the first-time homebuyer using your IRA funds for a down payment can be you, your spouse, one of your children, a grandchild or a parent.

You must use the IRA funds within 120 days of withdrawal to pay qualified acquisition costs. This includes the costs of buying, building or rebuilding a home, along with any usual settlement, financing or closing costs.

Different treatment for Roths

These homebuying IRA options apply to traditional retirement accounts. The rules are a bit different for a Roth IRA.

The $10,000 you take out for your first home is a qualified distribution as long as you’ve had your Roth account for five years. You can take out your retirement money without penalty, and because Roth earnings are tax-free, you’ll have no IRS bill, either.

If, however, you opened your Roth IRA less than five years ago, the withdrawal is an early distribution. As with a traditional IRA early withdrawal, a Roth holder can use the first-home exception to avoid the 10 percent penalty but might owe tax on earnings that are withdrawn.

You can reduce the tax bite by first withdrawing the already-taxed contributions you made to your Roth. IRS Publication 590-B, Distributions from Individual Retirement Arrangements (IRAs), has details.

Military exceptions

Members of the military reserves also can receive early IRA distributions without penalty. To qualify, the following conditions must be met:

  • You were ordered or called to active duty after Sept. 11, 2001.
  • You were ordered or called to active duty for a period of more than 179 days or for an indefinite period because you are a member of a reserve unit.
  • The distribution is from an IRA or from an elective-deferral plan, such as a 401(k) or 403(b) plan or a similar arrangement.

In addition, the early distribution cannot be taken before you received your orders or call to active duty or after your active-duty period ends.

Personnel eligible for this early withdrawal exception include members of the Army or Air National Guard; the Army, Naval, Marine Corps, Air Force or Coast Guard Reserves; and the Reserve Corps of the Public Health Service.

Allowable, but not preferable, distributions

Early IRA withdrawals also are penalty-free in a few other instances. Unfortunately, most of these are hardship situations that no taxpayer wants to face.

Hardship circumstances for penalty-free withdrawals:

  • Payment of excessive unreimbursed medical expenses.
  • Payment of medical insurance premiums while unemployed.
  • Total and permanent disability.
  • Distribution of account assets to a beneficiary after you die.

You also can get IRS-approved early access to your nest egg if you take IRA money on a specific schedule. Known as substantially equal periodic payments, this method allows you to begin withdrawing from your IRA early — as long as the amounts are determined by an IRS-calculated life expectancy table.

And don’t forget that the early withdrawal exceptions do not eliminate your tax bill if you take the money out of a traditional IRA. When you take the money out of such an account, regardless of your age or the purpose of the withdrawal, you’ll owe your regular tax rate on the amount.

You may find you have other, more preferable options, such as taking out a personal loan.