Taking money out early from your IRA may trigger an additional tax. Generally, amounts received from a traditional, SEP, or SIMPLE IRA are taxable distributions and must be reported as ordinary income for the taxable year in which they are received. If you are under age 59 1/2, any distributions received are considered early or premature distributions and are subject to an additional penalty tax equal to 10% of the taxable amount of the distribution. (It should be noted that that this penalty tax may be increased to 25% in the case of distributions from SIMPLE IRAs during the first two years of participation in the SIMPLE IRA.) However, the penalty tax does not apply in certain situations. Below is a list of exceptions to the additional penalty tax on early or premature IRA distributions pursuant to IRC Section 72(t).
The exceptions are as follows:
- Distributions made to the beneficiary or the individual’s estate in the event of the death of that individual.
- Distributions attributable to the individual’s disability.
- Distributions made for medical care to the extent allowable as a medical expense deduction for amounts paid during the taxable year which is in excess of 10% of the individual taxpayer’s Adjusted Gross Income (AGI).
- Distributions made to unemployed individuals for payment of health insurance premiums provided the individual has received unemployment compensation for at least 12 weeks and the withdrawal is made either in the same year the unemployment compensation was received or in the year immediately following the receipt of unemployment compensation. This exception may also apply to self-employed individuals who would otherwise not be eligible for unemployment compensation because they are self-employed.
- Distributions made to pay “Qualified Higher Education Expenses” during the taxable year for the taxpayer, the taxpayer’s spouse, child or grandchild of the taxpayer or the taxpayer’s spouse provided the distribution occurs within the year the expenses were incurred. A “Qualified Higher Education Expense” includes tuition, fees, books and equipment required for enrollment at any “eligible educational institution” which is defined as any college, university, vocational school or other post-secondary educational institution described in the Section 481 of the Higher Education Act of 1965. This also includes special needs services incurred in connection with such enrollment or attendance. Room and board, up to a certain amount, is also included provided the student is enrolled at least half-time. It’s important to note that these expenses are reduced by any scholarships or educational assistance received by the individual.
- Distributions that are ‘qualified first-time homebuyer distributions.
- Distributions that are part of a series of substantially equal periodic payments made (at least annually) for the life or life expectancy of the individual or the joint lives or joint life expectancy of the individual and his or her designated beneficiary.
- Distributions that are qualified hurricane distributions” which may not exceed $100,000.
- Distributions that are “qualified reservist distributions” which are distributions made to reserve members of the U.S. military called to active duty for 180 days or more at any time after September 11, 2001. But reservists have the right to return the amount of any distributions for two years following the end of active duty.
It’s important to note that these exceptions only apply to taxable IRA distributions and are different than the exceptions applicable to qualified plans. As always, you should consult your tax or legal advisor as to the best course of action based on your unique circumstances when considering taking an early distribution from an IRA. For more information please refer to IRC Section 72(t) and IRS Publication 590, Individual Retirement Arrangements, or the IRS Web site at www.IRS.gov.
The foregoing information regarding personal, estate, charitable and/or business planning techniques is not intended to be tax, legal or investment advice and is provided for general educational purposes only. You should consult with your tax and legal advisor regarding your individual situation.
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