IRA early withdrawal exceptions

Choosing to make an early withdrawal from your IRA can be a costly move, resulting in unfavorable consequences such as tax penalties and loss of future growth. To discourage the early collection of designated retirement money during taxpayers' working years, the federal government imposes a 10 percent penalty in addition to any tax due on gains. A withdrawal made earlier than age 59 1/2 could qualify for such a penalty unless an available exemption criterion is met. Even then, not all exempted withdrawals will be free of additional tax expense. The Pennsylvania Institute of Certified Public Accountants offers the following examples of instances when early withdrawals from an IRA may be less burdensome.

College tuition

In most cases it is OK to make an early withdrawal to pay higher education costs for you, your spouse, your children, or your grandchildren. As long as the eligible student attends an accredited school, either private or public, you can use retirement money to pay for tuition and fees, books, equipment, and other class supplies. Distributions to pay for room and board are also exempt from the 10 percent penalty, as long as the recipient is at least a half-time student.

These distributions, however, will be included in your taxable income and will be subject to regular tax. Since federal financial aid is based on your income situation, early draws on retirement funds could negatively affect a student's chances of qualifying for financial aid or push the IRA holder into a higher tax bracket. As such, you could end up paying more money than you anticipated.

First home purchase

You can use $10,000 in retirement funds toward the purchase of your first home. If you are married, this amount becomes $20,000 since you may each pull $10,000 from your respective retirement accounts.

The early withdrawal can be used to meet down payment requirements, pay for groundbreaking costs on new construction, or even rebuild your whitepicket fence. The IRS's interpretation of "first-time homebuyer" doesn't necessarily mean you have to be buying, building, or rebuilding an actual first-ever home; you would qualify for the exemption as long as you or your spouse did not own a home during the prior two-year period.

The timing of the early withdrawal is important, since the IRS requires the funds to be used within 120 days of the distribution. During that timeframe, should you cancel or reschedule the purchase or construction project, the money can be returned to your IRA without penalty.

Doctor bills and insurance

You can use IRA funds for medical expenses. The IRS will not penalize you should you need to pay for unreimbursed medical expenses that exceed 10 percent of your adjusted gross income. Timing is again important, as early withdrawal money for medical expenses must be used in the year the medical expenses are incurred.

Withdrawals to pay for health insurance for you, your spouse, or your dependents are acceptable if made following a period of unemployment.

Saving for retirement is an important long-term goal and taking a withdrawal for a more immediate need can be tempting. Tax implications should not be the only factor in determining how to fund current bills. Your local CPA can help you understand your money management issues. Be sure to contact him or her with all of your financial questions and concerns. To find a CPA by location, visit www.ineedacpa.org.