Early-Withdrawal Penalty Exceptions

• There are several cases where you can withdraw your money before age 59 1/2 without paying a 10-percent penalty. If your medical bills exceed 7.5 percent of your adjusted gross income (AGI), you can withdraw money from your IRA to cover bills in excess of this threshold. For example, say your AGI is $36,000. Then 7.5 percent of your income is $2,700. If your medical bills total $5,100, then you deduct $2,700 from that amount to get $2,400, which is the amount you can withdraw without penalty from your IRA to help pay your medical bills. If you qualified as unemployed, you can withdraw money to cover your medical insurance premiums. You can also withdraw money to cover higher educational expenses that you pay for yourself or a family member. Over your lifetime, you can withdraw up to $10,000 to contribute to a first-time home purchase for yourself or your descendants. Also, if you become permanently disabled, you are exempt from the early withdrawal penalty. Make sure that you can prove the expenses that you claim with receipts or other documentation in case your return is questioned by the IRS.
  
  

Documenting Your Early Withdrawal

• You must file IRS form 5329 with your 1040 tax return if you take an early distribution, regardless of whether the withdrawal is qualified or not. On this form, you can claim a portion or all of your withdrawal as penalty-free by writing the amount on line 2 and writing the code to signify the reason for the penalty-free status in the space next to line 2. The codes are found in the form 5329 instruction manual, available from the IRS website. Even if your withdrawal is completely qualified, you may still have to pay taxes on the withdrawal if you are taking it out of a traditional IRA, Simplified Employee Pension (SEP) IRA or SIMPLE IRA. Contributions withdrawn from a Roth IRA are not taxable. Your form 1099-R, that you will receive from your financial institution, will show the taxable portion in box 2a. Write the entire amount of the withdrawal on line 15a and the taxable portion on line 15b of your from 1040. This form is required for all IRAs. The only difference is that the penalty is 25 percent for SIMPLE IRAs instead of 10 percent if the withdrawal comes within two years of opening your SIMPLE IRA.
  
  

Substantially Equal Periodic Payments

• The IRS allows you to withdraw money from your IRA without paying the 10-percent penalty if you set up a substantially equal periodic payment system, also known as a 72t. This program allows you to start taking distributions early. However, you must continue to take the required distributions until you are 59 1/2 or five years have passed, whichever is longer. For people not close to 59 1/2, this will severely hamper your ability to take advantage of IRAs and the related tax breaks for retirement savings. The reason is you are not allowed to make contributes to your IRA while this program is in effect. If you decide to stop this program early, you have to pay early-withdrawal fees and interest charges.