Premature Withdrawals

Speaking of penalties, there are a number of rules limiting the withdrawal and use of your IRA assets. Violation of the rules generally results in taxation of the withdrawn amount as ordinary income plus a penalty equal to 10 percent of the withdrawal. The rules apply equally to SEP-IRAs and IRAs established under SIMPLE plans, except that the penalty for a withdrawal from a SIMPLE plan within the first two years of participation is 25 percent. Also, there are more lenient rules for Roth IRAs.

Generally, you violate the rules if you withdraw assets from your regular IRA before you reach the age of 59-1/2. However, there are a number of exceptions to these rules for cases that might be considered hardship withdrawals. If you can use any of these exceptions, you won't have to pay the penalty, but you will still be taxed at ordinary rates on the amount of the withdrawal. Also, you must complete IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, and give the reason that the distribution is escaping from the penalty.

First, if you become disabled before you reach age 59-1/2, you don't have to pay the additional 10 percent tax if you can furnish proof of your disability, as determined by your physician.

Second, you can receive distributions from your IRA that are a series of substantially equal distributions over your life (or life expectancy) or the lives of you and your beneficiary (or your joint life expectancies). You must use an IRS-approved calculation method, you must take at least one distribution annually, and you must continue the payment method until you reach age 59-1/2 or for five years, whichever is longer. If you want to take advantage of this exception, consult your tax advisor or get IRS Publication 590, Individual Retirement Arrangements, for further information.

Third, there is an exception that allows you to take penalty-free distributions from an IRA if the amounts are used to pay medical expenses in excess of 7.5 percent of adjusted gross income, or if the distributions are used to pay health insurance premiums for yourself, your spouse, or dependents if you lost your job, you received unemployment compensation for 12 consecutive weeks, you made the withdrawals during the year you were unemployed or the following year, and you made the withdrawals no later than 60 days after you were reemployed. Self-employed persons can use this exception if they would have met all the requirements except for the fact that they could not receive unemployment benefits because they had been self-employed.

Fourth, as of 1998, you can take a penalty-free withdrawal of up to $10,000 from any type of IRA to purchase a first home for yourself, your spouse, your child or spouse's child, your grandchild or spouse's grandchild, your parent or other ancestor, or your spouse's parent or other ancestor. A "first home" actually means the person's first home within the last two years.

Fifth, also as of 1998, you can take a penalty-free withdrawal from an IRA that is not a Roth IRA to pay certain higher education expenses for yourself, your spouse, your children, or your grandchildren. Qualified higher-education expenses include tuition, fees, books, supplies, or equipment; if the individual is at least a half-time student, room and board are also qualified expenses.

Sixth, under the Pension Protection Act of 2006, a qualified reservist distribution after August 17, 2006 from an IRA or attributable to elective deferrals under a 401(k) plan, 403(b) annuity, or certain similar arrangements are not subject to the 10 percent early withdrawal tax if a qualified reservist was ordered or called to active duty for a period in excess of 179 days.

Finally, if you make a contribution to an IRA (perhaps mistakenly), you take no deduction for it, and you withdraw your contribution before the due date (including extensions) of your income tax return for that year, the withdrawal is not a taxable distribution. However, any interest or income on the amounts (which must also be withdrawn) are treated as taxable income in the year the contribution was made. The income must be reported on Form 5329.