Early IRA withdrawals before age 59 ½ incur penalties, but two exemptions exist: the school exemption for higher education expenses and the first home exemption for down payments. Withdrawals must be used for qualified exemptions within 120 days to avoid penalties.
An IRA early withdrawal is the act of removing funds from an existing individual retirement account before reaching retirement age, or at least the calendar age of 59 ½. When this action is taken, there are often substantial penalties incurred as a result. However, there are two distinct exemptions for IRA early withdrawal activity that are roughly categorized as hardship distributions.
The first type of IRA early withdrawal that can escape taxes and other penalties is the school exemption. This has to do with providing higher education for the individual, a spouse, or a child or grandchild. However, simply choosing to use an IRA distribution through withdrawal to pay tuition and fees at any college or university is not enough to escape penalties. There are a few qualifications that must be met in order for an IRA early withdrawal not to incur taxes and other harmful penalties.
First, the IRA early withdrawal must be used to attend an educational institution that the Internal Revenue Service deems to be an approved college or university. To that end, it is important to make sure that the institution meets the necessary requirements to receive and administer federal student aid programs. Typically, the institution must also be recognized as currently accredited. Colleges and universities whose accreditation is currently under review or suspended may not qualify. This means that an IRA early withdrawal that is used to pay tuition and fees to schools that do not meet the requirements of the federal student aid program or are not currently accredited will be subject to taxes and penalties.
Second, an IRA early withdrawal can be obtained without penalties if the purpose of the withdrawal is to help buy a first home. Known as the first home exemption, it is possible to withdraw up to $10,000.00 United States Dollars (USD) from an IRA account and use the funds as a down payment on a first home. This figure is applicable for each IRA in place. This means that if both spouses currently have their own IRA, each spouse can withdraw up to $10,000.00 USD from each account. This would result in a total of $20,000.00 USD that could be used to purchase a home without incurring IRS penalties.
As a side note, the first homestead exemption can be applied to situations involving a close relative. A parent can participate in an IRA early withdrawal to help a child or grandchild obtain a first home. In the same way, a child can withdraw funds to help a parent obtain a home.
To avoid penalties associated with an early IRA withdrawal, funds must be used for a qualified exemption within 120 days of withdrawing the funds. If the exemption is not requested and granted during this time period, all normal taxes and penalties will apply. In cases where people want to use IRA funds for some other purpose, an IRA loan is probably a better solution.
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