Seven penalty-free ways to withdraw money from retirement accounts

Most financial planners and analysts recommend against withdrawing money from retirement accounts for anything except retirement. However, there are a few times when withdrawing from retirement can be penalty-free.

LM Otero/AP/File
In this Sept. 24, 2013 photo, freshly-cut stacks of $100 bills make their way down the line at the Bureau of Engraving and Printing Western Currency Facility in Fort Worth, Texas. Taxes can eat away at retirement withdraws.

While it's true that 401Ks have a higher contribution limit ($18,000 in 2015) than traditional IRAs and Roth IRAs ($5,500 for most people or $6,500 if you're age 50 or older in 2015), it would be a mistake to dismiss traditional IRAs and Roth IRAs as part of your retirement strategy.

One of the major advantages of having an IRA is that it offers much more flexibility when it comes to taking distributions before age 59 1/2. Under most circumstances, early distributions from a 401K trigger a 10% penalty fee from the IRS on top of applicable income and capital gains taxes. But IRAs are subject to far fewer limitations in many cases — often, they're free from the 10% penalty for early withdrawals.

Here are seven circumstances under which you can withdraw money before age 59 1/2 from an IRA without triggering an IRS penalty.

1. Health Insurance Premiums During Unemployment

If you're unemployed and can't jump on somebody's health plan for coverage, you're probably going to be stressed out about meeting your monthly premiums. Fortunately, once you've been unemployed for at least 12 continuous weeks, the IRS lets you take a penalty-free early distribution from your IRA to cover your health insurance monthly premiums. (To avoid any doubts about how you're using your IRA monies, consider opening a new bank account to handle deposits from your IRA and payments to your health provider.)

Some additional points to remember are that the IRA distributions need to take place during either the year you received the unemployment compensation or the following, and that the IRA distributions need to take place no later than 60 days after you have been reemployed.

2. Large Medical Bills

Uncle Sam also gives you a break when you use an IRA withdrawal to pay for unreimbursed medical expenses greater than 10% (or 7.5% if you or your spouse was born before January 2, 1950) of your adjusted gross income for the year of the distribution.

While the IRS doesn't require you to itemize your deductions to take advantage of this exception, you should keep a record of all of your medical, dental, and prescription expenses that weren't reimbursed or paid by others. Remember that you can't include the cost of non-prescription drugs (except insulin) or other purchases for general health, such as vitamins, diet foods, or health club dues. Costs of cosmetic procedures aren't eligible, either.

However, you can include 23.5 cents per mile that you drove your car for medical reasons. Refer to the Schedule A of Form 1040 to find out the entire list of eligible expenses that you can use to calculate your total unreimbursed medical expenses.

3. First Home Purchases

If the dream property for which you've been waiting so long finally becomes available and you're up to $10,000 short on the down payment, you can tap into your IRA without a penalty.

As long as your total IRA withdrawal for first-time home buying is not greater than $10,000, you can even split your withdrawals over more than one year. Not only can you use these monies to buy your own home, but also to pay qualified costs of buying, building, or rebuilding a property. Just make sure that those qualified costs are paid within 120 days after receiving your IRA distribution.

Attention couples: If you keep separate IRA plans, each one of you can withdraw up to $10,000 without penalty to pool at total of $20,000 for a first home purchase.

4. Higher Education Expenses

Whether it is for your own education or that of your spouse, children, or grandchildren, you can take a penalty-free withdrawal from your IRA to cover qualified higher education expenses, including tuition, fees, books, supplies, and equipment required for the enrollment or attendance at an eligible educational institution.

Other eligible education expenses include the cost of room and board for individuals that are at least half-time students and special needs services in connection with enrollment or attendance. While there is no limit to the amount of your withdrawal free from the 10% penalty tax, keep in mind that your monies may count as income for the student, and may thus impact their eligibility for financial aid.

5. Debts to the IRS

Uncle Sam wants so badly to collect on your unpaid taxes and arrears that he's willing to forego the 10% penalty tax on your IRA withdrawal. However, as in all other scenarios in this list, you do have to pay applicable income taxes, including capital gains.

While using part of your IRA balance to pay all or part of your tax debts may not sound that great, it's better than trying to avoid a levy. Under the second scenario, you may have no bargaining power.

6. Rollovers From Traditional IRAs to Roth IRAs

Unlike traditional IRAs, Roth IRAs are funded with after-tax dollars. This means that you don't owe any taxes on withdrawals after age 59 1/2. Plus, once your Roth IRA has been open for at least five years, you can withdraw your contributions at any time without penalty (note that earnings on your contributions are subject to IRS penalties).

If you were to transfer funds from your traditional IRA to a Roth IRA, you would pay applicable income taxes now, but no 10% penalty tax on contributions if you wait five years to withdraw those funds from your Roth IRA. Each transfer has its own five-year waiting period and you can only do one IRA rollover per year.

7. Periodic Income Distributions

Last but not least, you can take penalty-free distributions from your IRA by taking a series of substantially equal periodic payments (SEPP) over your life expectancy or the life expectancies of you and your designated beneficiary. The IRS website offers a useful list of frequently asked questions on setting up a SEPP plan.

If you're planning to set up a SEPP for early retirement, remember that there maybe some financial risks involved. So, before taking your first periodic income distribution, consult your accountant or financial advisor to check your calculations. (See also: 4 Reasons Early Retirement Might Be Financially Risky)

The Bottom Line

Taking an early distribution of your IRA may be a last resort to make your financial goals, such as a first home purchase, happen. As you can see from these seven examples, there are ways for you to take an early withdrawal from an IRA without the 10% tax penalty. While these strategies may not be for everybody, some of them can be true game changers. Consult IRS Publication 590-B for more details.

This article first appeared at Wise Bread.

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