By Andy Ives, CFP®, AIF®
When a person under the age of 59 ½ takes a withdrawal from their IRA or company plan – like a 401(k) – there is a 10% penalty. However, this penalty can be avoided if the withdrawal qualifies for an exception. Some exceptions apply to both IRAs and plans, some to plans only, and some to IRAs only. With the craziness that is our current world, the three IRA-only exceptions (including SEP and SIMPLE plans) may provide a lifeline for those in need. A general description of each is as follows:
First-Time Home Buyer
To qualify for the first-time home buyer exception, a person must not have owned a home for the previous two years. If you did previously own a home – but sold it more than two years ago and have not owned another home since – then you would qualify. Also, be aware that the amount of cash available through the first-time home buyer exception is not unlimited. It is capped at a maximum lifetime amount of $10,000. The $10,000 can be put toward a first-time home purchase by the IRA owner, the owner’s spouse, child or grandchild.
The money can be used to purchase, construct or reconstruct a home. This includes financing or settlement costs – but not home improvements. (Building a new outdoor kitchen will not qualify.) Refinancing also does not count…because you owned a home within two years. Any dollars withdrawn must be used within 120 days of distribution, and a married couple can use $10,000 each.
Higher Education Expenses
IRS guidance defines an “eligible educational institution” as “any accredited public, nonprofit, or proprietary (privately owned profit-making) college, university, vocational school or other postsecondary educational institution. Also, the institution must be eligible to participate in a student aid program administered by the U.S. Department of Education.” If your school meets these guidelines, then the higher education expenses exception may be available. (It is not available to cover costs associated with primary or secondary school – i.e., high school.)
The education expenses can be for the IRA account owner, his or her spouse, child, or grandchild of either the owner or spouse. Nieces, nephews, cousins and siblings do not qualify. As for the timing of the withdrawal, IRA distributions must be taken in the same calendar year that the bill is paid.
Health Insurance if you are Unemployed
This exception can be used for the health insurance costs of the IRA owner, spouse or dependents. To qualify for this exception, the IRA distribution must be taken in the year (or the following year), when the IRA owner received unemployment compensation for 12 consecutive weeks. However, once a person finds a new job and is re-employed for 60 days, the distribution exception is no longer available.
Do not make the mistake of thinking that all exceptions apply to all accounts. Should you need to access your retirement dollars before age 59 ½ for emergency funding, be sure to understand which penalty exceptions might be available – and which ones are not.