IRA Early Withdrawal Rules & Penalties

Both a traditional and Roth IRA can play an important role in any retirement plan. These accounts offer important tax advantages at either the time of contribution or in retirement, but they also have some pretty specific rules regarding when that money can be accessed.

Read on to learn the rules retirees need to follow when accessing their tax-advantaged savings accounts. We’ll also go over what qualifies as an early withdrawal from these accounts, the IRA withdrawal penalty rules, and how to avoid paying any of these penalties on distributions when taking money out of an IRA.

What are early withdrawal penalties?

As the name implies, a withdrawal penalty is a fee imposed when an account holder pulls money out of certain types of savings vehicles ahead of schedule. This fee is typically triggered when withdrawing savings earlier than the timeline allowed by the institution or the nature of the account itself.

Early withdrawal penalties are commonly seen on various types of “locked” savings accounts, such as those held at financial institutions operating under federal regulation. These penalties could affect everything from certificates of deposit (CDs) to individual retirement accounts (IRAs), 401(k)s, and more. These fees may be accompanied by additional taxes and, depending on the type of account, premature account closure.

Understanding traditional and Roth IRA withdrawal rules

Both traditional and Roth IRAs are subject to certain federal regulations. These IRA withdrawal rules dictate when funds can (or must) be withdrawn and the penalties imposed for withdrawing funds early.

Traditional IRA withdrawal rules

With traditional IRAs, employees are able to save for retirement with tax-deductible dollars. These savings (up to $6,000 per year for 2021 and 2022, or up to $7,000 for those 50 and older) grow tax-free until retirement, when they can be withdrawn and then taxed as ordinary income.

Standard withdrawals of contributions and growth are allowed beginning at the IRA withdrawal age of 59½. Any withdrawals taken then are subject to ordinary income taxes, at the owner’s  tax rate in the year of the withdrawal.

Once the account holder reaches a certain age, they must begin withdrawing funds (known as required minimum distributions, or RMDs). Failure to withdraw these funds can result in a 50% excise tax on the portion of the RMD that wasn’t distributed. Before 2019, this age was 70½; thanks to the SECURE Act, retirees can now wait until age 72 for RMDs.

If funds are withdrawn from a traditional IRA before age 59½, the account owner is subject to an IRA early withdrawal penalty tax of 10% on top of the income taxes they must pay on the funds. However, there are exceptions to this blanket rule.

Withdrawals from a traditional IRA before age 59½ are not subject to early withdrawal penalties in the following situations:

• An investor becomes disabled.

  If an investor becomes disabled before age 59½ and is unable to remain gainfully employed, they can withdraw from their IRA to pay for expenses related to their disability, without penalty.

• An investor gives birth to or adopts a child.

  Up to $5,000 per child can be withdrawn from a traditional IRA to pay for expenses related to birth or adoption. These funds can also be repaid into the account.

• An investor has unreimbursed medical expenses.

  If an investor had medical expenses that were not reimbursed and accounted for more than 7.5% of their adjusted gross income (AGI), they don’t have to pay the 10% penalty tax on the amount they spent beyond 7.5% of their AGI.

• An investor loses a job and needs to pay medical insurance premiums.

  Investors who lose a job can use their IRA to pay for qualifying medical insurance premiums for themselves, their spouse, and their dependents, without early withdrawal penalty. They’ll need to meet certain IRS requirements to qualify.

• An investor pays higher education expenses.

  Some or all of an early distribution may be exempt from penalty if an investor used the funds for higher education expenses. These might include qualifying educational expenses (tuition, books, fees, room and board) for themselves, their spouse, children, or grandchildren.  

• An investor buys or builds a first home.

  Early withdrawal penalties are waived on up to $10,000 in early IRA withdrawals if investors buy, build, or rebuild their first home. These qualified acquisition costs must meet certain requirements; an investor and their spouse can take advantage of the exclusion from their individual accounts for a maximum of $20,000 combined.

• A reservist is ordered or called to active duty.

  Qualified reservists can withdraw from their IRA without penalty if they were ordered or called to active duty service after September 11, 2001.
  

Under the CARES Act

, IRA account holders could also withdraw money in 2020 without penalties. This money could be used for any number of hardship-related expenses due to the pandemic and could be repaid if borrowers wished.

Roth IRA withdrawal rules

With a Roth IRA, the rules are a bit different because Roth IRA contributions are made with after-tax dollars. There are no tax deductions on contributions, so they can be withdrawn at any time without penalty.

Any earnings on those contributions, however, follow a different set of rules. For starters, there is no required minimum distribution (RMD) for a Roth IRA. The money can sit in the account for the rest of the account holder’s life. When the account holder dies, the beneficiary must take all withdrawals within 10 years.

To withdraw earnings from a Roth IRA, two primary requirements must be met: Investors must be at least age 59½ and the account needs to have been open and funded for at least five years.

Withdrawals of earnings before age 59½ or meeting the five-year rule may be subject to the early withdrawal penalty tax of 10%. Exceptions are the same as traditional IRAs, so investors can avoid the penalty if they:

• Become disabled
• Give birth to (or adopt) a child
• Have unreimbursed medical expenses
• Lose a job and need to pay health insurance premiums
• Paid certain higher education expenses
• Buy or build a first home
• Are a reservist ordered or called to active duty

FYI: Try Titan’s free Roth IRA Calculator to project how much your Roth IRA will give you in retirement.

The bottom line

Individual retirement accounts, or IRAs, can be an important retirement savings tool that offers tax advantages. The IRS provides guidelines to help investors avoid triggering a taxable event and/or being subject to early withdrawal penalties.