How to Avoid the Early Withdrawal Tax Penalty From Your IRA
A common mistake that many IRA owners make is taking early withdrawals. These are withdrawals before the account holder has reached age 59 1/2. These withdrawals are subject to a 10% early withdrawal tax penalty on top of their regular income tax. However, there is an exception that allows first-time homebuyers to withdraw up to $10,000 without incurring an early withdrawal tax. If you are forced to withdraw early, there are steps you can take to avoid incurring an early withdrawal tax penalty.
If you plan to take early withdrawals from your retirement account, you should consider if you can avoid paying the 10% penalty. There are certain exceptions to this tax, including hardship withdrawals for higher education or first-time home purchases. But if you do not qualify for an exception, you should consider making a taxable withdrawal to cover any unforeseen expenses. And, you should keep a healthy emergency fund.
The Rule of 55 will protect you from paying the early withdrawal tax penalty if you retire before age 55. You can use this rule to your advantage if you decide to leave your job before turning 55. Another option is to roll over your old 401(k) account into your new one. By doing so, you’ll be able to access the money you’ve built up in your account. If you’re a little unsure about whether or not this strategy will work for you, talk to your financial advisor or tax professional. You may be surprised at the amount of money that you can withdraw without incurring a penalty.
If you are planning to take money from your TSP, you should check with the plan administrator for Form 1099-R. The form contains information about any pension, annuity, or profit-sharing plan distributions. It will also have a numeric code. Look for this numeric code to avoid the early withdrawal tax penalty. You should send this form to your beneficiaries. It will also include any distributions from an insurance policy or a contract.
Another way to avoid the early withdrawal tax penalty is to withdraw your retirement funds to cover unreimbursed medical expenses. These must be more than 7.5% of your AGI. Moreover, withdrawals must be made in the year when you incur medical bills. For more information, consult IRS publication 590. If you’re unemployed and paying health insurance premiums, you can avoid the tax penalty by utilizing the rule for people who have no income and are totally and permanently disabled.
A traditional IRA can be used for significant medical expenses. If you meet the requirements, you won’t incur the 10% early withdrawal tax penalty. Smaller medical expenses should come from your normal monthly budget. However, if you have large medical expenses, you can withdraw the money from your IRA and avoid the tax penalty. The medical expenses should be higher than 10% of your adjusted gross income. In addition, your withdrawal must be for medical expenses that are not covered by your insurance.