Saving enough money to retire comfortably is a goal every American strives for. But let’s face it life can sometimes throw you a curve ball and you may need to use some of those funds before you reach retirement age. The federal government established IRAs in 1974 with the passing of the ERISA act. They also made it clear that receiving the funds prior to the age of 59 ½ would cause a premature distribution and penalties would apply. But did you also know that they determined that people may need to take an early distribution to help relieve the financial burden of a personal hardship? In this scenario, you may be able to take an early distribution of your funds without incurring the cost of a penalty. The IRS has outlined certain distributions from an IRA that are used for expenses similar to those that may be eligible for hardship distributions from a retirement plan are exempt from the additional tax on early distributions. Specifically, a distribution from an IRA for higher education expenses or to finance a first-time home purchase is exempt from the early distribution tax.
After you reach age 59 ½ you can receive distributions without having to pay the 10% additional tax. There are several exceptions to the 59 ½ rule. If you receive a distribution before you reach age 59 ½ you may not have to pay the additional tax of 10% if you are in one of the following situations:
* You have unreimbursed medical expenses that are more than 10% (or 7.5%, if you or your spouse was born before January 2, 1952) of your adjusted gross income.
* The distributions are not more than the cost of your medical insurance due to a period of unemployment.
* You are totally and permanently disabled.
* You are the beneficiary of a deceased IRA owner.
* You are receiving distributions in the form of an annuity.
* The distributions are not more than your qualified higher education expenses.
* You use the distributions to buy, build, or rebuild a first home.
* The distribution is due to an IRS levy of the qualified plan.
* The distribution is a qualified reservist distribution.
Let’s review specifics for the most common exceptions.
Unreimbursed medical expenses. You do not have to pay the 10% additional tax on distributions that are not more than, the amount you paid for unreimbursed medical expenses during the year of the distribution, minus 10% of your adjusted gross income for the year of the distribution. You can only take into account unreimbursed medical expenses that you would be able to include in figuring a deduction for medical expenses on Schedule A/Form 1040. You do not have to itemize your deductions to take advantage of this exception to the 10% additional tax.
Medical insurance. You may not have to pay the additional 10% tax on distributions during the year that are not more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You will not have to pay the tax on these amounts if all the conditions below apply:
* You lost your job
* You received unemployment compensation paid under any federal or state law for 12 consecutive weeks because you lost your job
* You receive the distributions during either the year you received the unemployment compensation or the following year
* You receive the distributions no later than 60 days after you have been unemployed
Disability. If you become disabled before you reach age 59 ½ any distributions from your traditional IRA because of your disability are not subject to the 10% additional tax. You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration.
Higher education expenses. If you paid expenses for higher education during the year, part (or all) of any distribution may not be subject to the 10% additional tax. The part not subject to the tax is generally the amount that is not more than the qualified higher education expenses for the year for education furnished at an eligible educational institution. The education must be for you, your spouse, or the children or grandchildren of you or your spouse.
When determining the amount of the distribution that is not subject to the additional tax, include qualified higher education expenses paid with any of the following funds, payment for services (such as wages), a loan, a gift, an inheritance given either to the student or the individual making the withdrawal and/or a withdrawal from personal savings. DO NOT include expenses paid with any of the following funds, tax-free distributions from a Coverdell education savings account, tax-free part of scholarships and fellowships, Pell grants, employer-provided educational assistance and/or any other tax-free payment (other than a gift or inheritance) received as educational assistance.
Qualified higher education expenses include tuition, fees, books, supplies and equipment required for the enrollment or attendance of a student at an eligible educational institution. If the individual is at least a half-time student, room and board are also considered higher education expenses. An eligible educational institution is any college, university, vocational school or other postsecondary educational institution eligible to participate in the student aid programs administered by the US Department of Education. It includes virtually all accredited, public, nonprofit and proprietary postsecondary institutions. The education institution will be able to tell you if it is an eligible educational institution.
First Home. You do not have to pay the 10% additional tax on up to $10,000.00 of distributions you receive to buy, build, or rebuild a first home. To qualify for treatment as a first-time homebuyer distribution, the distribution must meet all of the following criteria:
1. It must be used to pay qualified acquisition costs before close of the 120th day after the day you received it. Qualified acquisition costs include cost of buying, building, or rebuilding a home and any usual or reasonable settlement, financing, or other closing costs.
2. It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer who is any of the following: yourself, your spouse, your or your spouse’s child, grandchild, parent or other ancestor. You are a first-time homebuyer if you had no present interest in a main home during the 2-year period ending of the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.
3. When added to all your prior qualified first-time home buyer distributions, if any, total qualifying distributions cannot be more than $10,000.00.
The date of acquisition is the date that you enter into a binding contract to purchase the main home for which the distribution is being used or the building or rebuilding of the main home for which the distribution is being used begins.
If both you and your spouse are first-time home-buyers each of you can receive distributions up to $10,000.00 for a first home without having to pay the 10% additional tax.
For more information on early distribution exceptions from an IRA please go to www.irs.gov