Most of us should be diligently socking money away in retirement accounts such as IRAs, to build war chests to support us in retirement. It's best to leave the money in such accounts without withdrawing it until you need it in your golden years, but sometimes you might find yourself wanting to take some money out early. Generally, that will result in a 10% penalty. There are some exceptions, though. Read on to learn about three ways to withdraw from your IRA before retirement -- penalty-free!
Selena Maranjian: One way to withdraw money from an IRA early and without facing penalties is if you do so to buy your first home -- whether you put the money toward your down payment or toward building the home. The rules allow you to withdraw up to $10,000 for that purpose, without having to pay the 10% early withdrawal penalty. If you're married and it will be your spouse's first home, too, then each of you can take out $10,000, giving you a significant chunk of change. (That $20,000 alone would make up a 20% down payment on a $100,000 home, or half the down payment on a $200,000 one.)
How does the IRS define first-time homebuyer? Well, you only have to have been without any ownership stake in a home during the two years before getting your new home. So yes, you can take advantage of this rule multiple times in your life -- though your total lifetime first-time homebuyer withdrawals are capped at $10,000. These withdrawals are also permitted if you're helping a child, grandchild, parent or some other qualifying relative buy a first home.
Of course, just because you can take money out of your IRA for a down payment doesn't mean you should. Doing so may help you get into a home, but it can also hurt your retirement, possibly significantly. Imagine, for example, that at age 35, you take $10,000 out of an IRA for a down payment. You get a home, but that $10,000 might have kept growing for you for 30 more years, until you retired at 65. If it grew by an annual average of 10%, it would have become almost $175,000, a very useful sum. If your spouse also withdrew $10,000, the two of you will have lost close to $350,000 in retirement funds. (Yes, your home might have appreciated in that time, but overall, real estate tends to grow in value much more slowly than the stock market.)
Matt Frankel: Another way to avoid the early withdrawal penalty is to use the money you take out from your IRA for qualified higher education expenses. Those include such things as tuition, fees, books, and supplies required for attendance at an eligible institution. Room and board is also an acceptable expense if the student is enrolled more than half-time. Essentially, postsecondary institutions eligible to participate in a federal student aid program are eligible, and the student can be you, your spouse, your child (including adopted or foster children), or any of their descendants, such as a grandchild.
However, if you do withdraw money for education, be aware that some expenses associated with attending school don't count. For example, the cost of transportation to, from, or around school is not a qualified expense, nor are any personal living expenses.
Unlike the first-time homebuyer exemption, there is no dollar limit on the ability to use IRA funds for higher education costs. Rather, the exemption is only limited by the cost of attendance -- for instance, if all of the qualified expenses for a semester of college add up to $12,000, that's what you can withdraw penalty-free. Because of this, it's rather common for people to use IRAs for the specific purpose of saving for college.
Jason Hall: Selena and Matt describe two situations that usually happen when things are going well. The IRS's rules for IRA withdrawals take rainy days into consideration as well. Specifically, you can take distributions penalty-free under the following situations:
- You are permanently disabled.
- You have unreimbursed medical expenses exceeding 10% of your adjusted gross income.
- To cover health insurance premiums while unemployed.
- You are the beneficiary of the IRA owner, who has died.
Ideally, we should all have a substantial "rainy day" savings to keep us from having to dip into our retirement savings, but sometimes it's just not enough. If you find yourself in one of the situations above, you can avoid the 10% early withdrawal penalty and tap an IRA to help make ends meet.
Early withdrawals that are penalty free can be a great help and can be very tempting. But remember that any money you remove from your retirement account will no longer be able to grow for you. You might really miss the dollars you would have had, once you find yourself in retirement.
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