How Can I Avoid Penalty on Early Withdrawal on an IRA?
Early-withdrawal penalties are assessed by the Internal Revenue Service for taking money out of the IRA structure before meeting normal distribution requirements. The normal distribution requirements are slightly different in a Roth IRA compared to a traditional IRA. The IRS does have exceptions allowing early distributions without the 10 percent penalty.
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Early Distributions
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Two types of IRA structures exist: traditional and Roth. The traditional IRA adds distributions to income taxes when money is taken out since there was an income tax deduction when contributions were made. Roth IRAs don't add distributions to income because no deduction was taken when contributions were made. Both types of IRAs have an age threshold for normal distributions, 59 1/2 years, with anything taken out early being penalized. The Roth has a second condition, requiring the account to have been funded for at least five years, regardless of IRA owner age. Failure to meet these requirement results in an early distribution that is penalized unless an exception applies.
Extreme Circumstances
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The IRS has hardship distribution rules applied to early distributions in which the IRA owner is experiencing extreme financial difficulties. Distributing funds for income, whether irregularly or not, when the owner is permanently disabled is allowed without penalty. Using distributions to pay medical expenses not covered by health insurance and that exceed 7.5 percent of the owner's annual income are exempt. Beneficiaries do not pay penalties on inherited IRA assets distributions, though they must add taxable distributions to income taxes.
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Major Expenses
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There are exceptions for major expenses that are not necessarily a hardship. The IRA owner may use up to $10,000 to buy a first home. In fact, using the funds for building or remodeling a home is allowed too whether for the IRA owner, a child or grandchild. Paying college expenses is another exception when the college is an accredited program. Funds are allowed for tuition, books, fees and even room and board. The exception applies if the owner uses the funds for himself, a spouse, child or grandchild.
Annuitize the IRA
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Annuities are bought to provide income streams, whether now or later. Electing the income stream is called "annuitization." You can annuitize anytime, at any age without penalty. The exemption applies as long as the IRA owner takes regular periodic payments at least once per year based on life expectancy tables according to IRA Regulation 72(t). Payment amounts must be equal and continue for a minimum of five years or until the owner is 59 1/2.
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