While your individual retirement account (IRA) is designed to support you in your golden years, life’s unpredictability may necessitate accessing your retirement funds earlier than planned.
Typically, early withdrawals from IRAs incur a hefty 10% penalty, but there are a few exceptions to this rule that can provide some financial flexibility in times of need without derailing your long-term retirement plan.
Read on to learn about five exceptions to the 59 1/2 rule that allow you to tap into your savings penalty-free.
Key Takeaways
- The 59 1/2 rule imposes a 10% penalty on early IRA withdrawals.
- Exceptions to the 59 1/2 rule include first-time home purchases, disability, and higher education expenses.
- You should consult a specialized financial advisor when considering early withdrawals.
Table of Contents
IRA Withdrawal Rules Explained
Before we dive into the exceptions, let’s go over the basic rules governing IRA withdrawals.
Notably, there are two main types of IRAs: traditional and Roth, each with its own set of rules.
Traditional IRA
Traditional IRAs are funded with pre-tax contributions, meaning you get a tax deduction in the year you make the contribution.
However, this tax benefit comes with a catch:
- With a traditional IRA withdrawal, you’ll pay income taxes on the entire amount withdrawn, including both your contributions and any earnings.
- If you withdraw money before age 59 1/2, you’ll typically face an additional 10% early withdrawal penalty on top of the income taxes.
- Once you reach the age of 73, you’re required to start taking Required Minimum Distributions (RMDs) from your traditional IRA account.
Roth IRA
Roth IRAs are funded with after-tax dollars.
This means you don’t get an immediate tax deduction, but it does offer several other benefits that include:
- You can withdraw your contributions (but not your earnings) at any time, without taxes or penalties.
- After age 59 1/2, if the account has been open for at least 5 years, you can withdraw both contributions and earnings tax-free and penalty-free.
- If you withdraw your earnings before the age of 59 1/2 or before the account has been left open for 5 years, you may owe income taxes and a 10% penalty.
- Unlike traditional IRAs, Roth IRAs aren’t subject to RMDs during the owner’s lifetime.
5 Most Common Exceptions to the 59 1/2 Rule
With the rules out of the way, let’s dive into the five most common exceptions to the 59 1/2 rule that you should be aware of:
1. Unreimbursed Medical Expenses
If you face significant unreimbursed medical expenses, you may qualify for penalty-free withdrawals from your IRA.
The unreimbursed expenses must exceed 7.5% of your adjusted gross income (AGI) for the year of the withdrawal to be eligible.
So, let’s say your AGI is $200,000 and you have $20,000 in unreimbursed expenses.
In that case, you’re allowed to withdraw up to $5,000 ($20,000 – (7.5% of $200,000)) from your IRA without incurring the 10% penalty.
This exception can be particularly valuable if you’re facing unexpected medical costs not covered by insurance.
2. First-Time Home Purchase
Buying a house is a major milestone, and the IRS recognizes this by allowing you to make a lifetime withdrawal of up to $10,000 from your IRA with no penalty for a first-time home purchase.
This exception applies not only to your personal home purchase but also to that of your children, grandchildren, or parents.
So, if you’re looking to establish roots in a community or help a family member achieve homeownership, this exception can be valuable.
Note: You must use the funds within 120 days of withdrawal for expenses directly related to buying, building, or rebuilding a home, including closing costs.
3. Qualified Higher Education Expenses
The IRS allows you to make penalty-free withdrawals from your IRA to cover qualified higher education expenses—tuition, fees, books, and supplies—required for enrollment at an eligible educational institution.
Room and board expenses may also qualify if the student is enrolled at least half-time.
4. Disability
In the unfortunate event of a total and permanent disability that prevents you from practicing medicine or engaging in any substantial gainful activity, you can withdraw from your IRA without penalty.
The disability must be long-term or of indefinite duration, and it can be physical or mental in nature.
It’s important to understand that the IRS has specific criteria for what qualifies as a disability and that you may need to provide proper documentation to prove it.
5. Substantially Equal Periodic Payments
If you’re considering early retirement or need a steady income stream before reaching 59 1/2, you should learn about the Substantially Equal Periodic Payments (SEPP) exception.
It allows you to withdraw IRA funds at no penalty by setting up a series of substantially equal payments based on your life expectancy or the joint expectancies of yourself and your designated beneficiary.
To qualify, you must continue these payments for at least 5 years or until you reach age 59 1/2, whichever comes later.
The amounts you withdraw are calculated using one of three IRS-approved methods.
As you’d expect, this option is complex and requires careful planning to avoid potential pitfalls.
Other Exceptions to the 59 1/2 Rule You Should Know
Other less common exceptions that allow for penalty-free withdrawals from IRAs under specific circumstances include:
- Health insurance premiums while unemployed
- Fulfilling an IRS levy
- Qualified military reservists called to active duty
- Inherited IRAs
- Qualified birth or adoption expenses
- Disaster recovery
- Emergency personal expenses
- Returned IRA contributions
Considerations and Recommendations
While the above-discussed exceptions offer potential avenues for accessing your IRA funds early without penalty, it’s important to approach such decisions with caution, as early withdrawals can significantly impact your long-term retirement savings due to the loss of compound growth.
Additionally, even if you avoid the 10% penalty, you may still owe income taxes on the withdrawn amounts, particularly from traditional IRAs.
On that account, we must remind you that these exceptions are designed to provide financial flexibility in specific circumstances.
They’re not to be treated as a primary means of accessing retirement funds.
If possible, you should explore alternative solutions before tapping into your IRA.
Some options include emergency funds, health savings accounts (HSAs), or other investment vehicles that may offer more liquidity.
It’s advisable to consult with a financial advisor who specializes in physicians’ finances to fully understand the implications of early withdrawals on your overall financial plan and make an informed decision.
