Ways to Avoid the IRA Early Withdrawal Penalty
In March through July, many workers found some help from virus job losses and layoffs in a combination of savings, unemployment, and credit. What are the next steps if employment does not return, and government programs are not renewed? Financial experts have urged people not to look to their 401(k) retirement accounts for loans. Although the maximum loan limit was increased as part of virus relief to $100,000 from $50,000, a retirement loan should be considered a last resort. If you borrow from your vested retirement savings, you typically have five years to pay it back.
Plans tapped A Bankrate study showed that 31 million people had tapped their plans already, or they expect to. As of August, 14 percent of Americans had used retirement funds. About 13 percent planned to do so. For those unemployed during the COVID crisis, about 50 percent tapped retirement plans. About 20 percent of Millennials hit their accounts as of August. Overall, the majority have continued paying into their 401(k) accounts, although 18 percent contributed less due to the crisis. According to Bankrate, younger households were most likely to turn to their 401 (k), while older families were the least likely. The top reason for not contributing to the 401(k) or cutting contributions was the loss of income (62 percent). About 33 percent said they wanted to have cash on hand. As you might expect, the 401(k) drain was concentrated among households making less than $50,000. Do not default the significant risk is the default when you take a 401(k) loan. You will be slapped with a 10 percent early withdrawal fee and then taxed on the money. In a 10 percent tax bracket that could cost you $200 for every $1,000 you borrow. Distributions from individual retirement accounts before age 59 1/2 typically trigger a 10% early withdrawal penalty. Though, the IRA withdrawal rules contain more than a few exceptions to the penalty if you meet certain circumstances or spend the money on specific purchases. Listed below are ways to avoid heavy penalty if you withdraw from your 401K.
An IRA withdrawal for medical expenses
IRA distributions used to pay for medical expenses that are not reimbursed by health insurance and surpass 10% of your adjusted gross income are not subject to the early withdrawal penalty.
An IRA withdrawal to pay for health insurance
If you lose your job and collect unemployment for twelve consecutive weeks, you can take penalty-free IRA distributions if you use the money to pay for health insurance for you or your spouse or children.
An IRA withdrawal to pay for a disability
Individuals with severe physical and mental disabilities who are no longer able to work can take IRA withdrawals without penalty if their physician to sign off on the seriousness of the condition.
An IRA withdrawal for college costs
Penalty-free IRA distributions can pay for college, including tuition, fees, books, supplies and equipment. Room and board also count if the individual attending college is at least a half-time student.
An IRA withdrawal for a first home purchase
You can withdraw up to $10,000 ($20,000 for couples) from an IRA to buy or build a first home without incurring the early withdrawal penalty. To qualify for the exemption, you must not have owned a home for the two years prior the home purchase.
An IRA withdrawal for military service
Members of the US military reserves who take an IRA distribution during a period of active duty of more than 179 days do not have to pay a 10% penalty on the amount withdrawn.
A Roth IRA withdrawal
A Roth IRA early withdrawal has fewer restrictions. You might be able to withdraw your contributions, but not the earnings, from a Roth IRA that is at least five years old without encountering the early withdrawal penalty.