IRA Hardship Withdrawal: How to Avoid Penalties

When financial emergencies strike, your retirement savings might seem like a tempting source of quick cash. However, tapping into your IRA early typically comes with significant consequences. Understanding the rules around IRA hardship withdrawals can help you navigate difficult financial situations while minimizing the impact on your retirement security. While the IRS doesn’t technically allow “hardship withdrawals” from IRAs the way they do with 401(k)s, there are several exceptions that permit early access to IRA funds without the standard 10% penalty.

A financial advisor can also help you navigate difficult situations with all of your investments.

IRA Hardship Withdrawal Rules

The IRS allows you to make penalty-free withdrawals from your traditional IRA once you reach age 59.5. Otherwise, you’d owe a 10% early withdrawal penalty and ordinary income taxes. However, the IRS waives the 10% penalty in certain situations.

Generally speaking, you can take an IRA hardship withdrawal to cover the following expenses:

Unreimbursed medical expenses that exceed more than 7.5% of adjusted gross income (AGI)
Qualified higher education expenses
Purchasing your first home (no penalty on up to $10,000 early withdrawal)
Certain expenses if you’re a qualified military reservist called to active duty

But keep in mind that traditional IRAs are tax-deferred savings vehicles. This means that you’d always owe income tax on any withdrawals you make. An IRA hardship withdrawal just spares you the 10% early withdrawal penalty. Plus, you can’t withdraw more than you need to cover your financial burden.

If the account holder of an IRA dies, his or her beneficiaries may take penalty-free hardship withdrawals in most cases. However, the surviving spouse may face a penalty if he or she decides to turn the inherited IRA into a personal one and makes a withdrawal before reaching age 59.5.

IRA Hardship Withdrawals for Medical Expenses

If you’ve racked up a serious medical bill, you may be able to tap into your IRA penalty-free to cover it. The IRS allows you to take a hardship withdrawal to pay for unreimbursed qualified medical expenses that don’t exceed 7.5% of your AGI. This represents your taxable income minus specific deductions you claim, such as student loan interest paid for the year.

Fortunately, qualified medical expenses fall under a relatively large umbrella. It covers most medical, dental and vision treatments that diagnose, prevent or treat disease. The rules generally allow you to take an IRA hardship withdrawal to cover most annual checkups, prescriptions and surgeries. However, qualified medical expenses typically don’t include elective procedures, but may include needs such as most plastic surgeries.

In addition, you have to take the IRA hardship withdrawal during the same calendar year that you incurred your medical bills. So let’s say you have surgery coming up next year. You can take the hardship withdrawal now as long as you use it to pay for the surgery before the end of the year. And that holds even if you won’t go through the procedure until next year.

As long as you follow this rule, you can include those medical expenses in your tax return along with Form 5329 to avoid the 10% early withdrawal penalty. However, you don’t have to itemize deductions.

You can also take a penalty-free hardship withdrawal if you’ve experienced “total and permanent disability.” One of the easiest ways you can prove this and avoid the early withdrawal penalty is by taking disability payments from an insurance company or through Social Security.

IRA Hardship Withdrawals for Health Insurance Premiums

IRA hardship withdrawals for health insurance premiums are available to those experiencing specific financial difficulties. To qualify, you must have received unemployment compensation for at least 12 consecutive weeks, and the withdrawal must occur either during the year you received unemployment or within the following year. These withdrawals are specifically designed to help individuals maintain health coverage during periods of financial strain.

While hardship withdrawals for health insurance premiums avoid the typical 10% early withdrawal penalty if you’re under 59½, they aren’t completely tax-free. The withdrawn amount still counts as ordinary income on your tax return. This means you’ll need to plan for potential tax liability when determining how much to withdraw to cover your insurance needs.

Proper documentation is essential when making an IRA hardship withdrawal for health insurance premiums. You’ll need to maintain records of your unemployment compensation, proof of health insurance premium payments and the timing of withdrawals. These documents are crucial for verifying eligibility if the IRS questions your withdrawal during a tax audit.

IRA Hardship Withdrawals for First-Time Homebuyers

IRA Hardship Withdrawal: How to Avoid Penalties

Considering owning your home, anticipating trouble paying off your mortgage? The IRS offers a solution. You can take an IRA hardship withdrawal to pay it down. But you can only do so if you haven’t owned another home in the last two years.

However, this kind of withdrawal can’t exceed $10,000. That’s your lifetime limit. So you can take out multiple withdrawals to cover the costs associated with purchasing a home. But the combined total can’t be more than $10,000 to avoid the penalty.

IRA Hardship Withdrawals for College Expenses

The IRS allows you to take early withdrawals from your traditional IRA penalty-free to cover qualified higher education expenses at postsecondary schools. That covers anything beyond high school, including vocational schools. You can typically use your hardship withdrawal to pay for the following:

Tuition
Books and supplies needed for enrollment
Room and board

You can use the hardship distribution to pay for qualified higher education expenses you, your children or other immediate family members incur.

However, the student benefiting from the distribution must be enrolled at a postsecondary school at least half-time while pursuing a degree. Otherwise, the IRA owner can’t avoid the early withdrawal penalty.

In addition, you must pay the qualified education expenses during the same year you withdrew funds from your traditional IRA to steer clear of the penalty.

However, taking an IRA hardship withdrawal to pay for qualified education expenses may affect the student’s eligibility for financial aid. When you take money out of your IRA and cover educational expenses, the government factors in the withdrawal as the student’s income for the following year. This means it could have a substantial impact when filling out the Free Application for Federal Student Aid (FAFSA).

But if you’re worried about future educational expenses, you may benefit by opening a 529 college savings plan. These state-sponsored savings vehicles offer several tax breaks. For instance, you can take money out of the plan tax-free at any time to pay for qualified higher education expenses.

Substantially Equal Periodic Payments (SEPP)

A special rule in the tax code allows you to make penalty-free withdrawals from a traditional IRA even if you’re younger than 59.5. You can take advantage of this rule by taking at least five substantially equal periodic payments (SEPP) based on your life expectancy as set by the IRS.

You must take these payments for five years or until you reach age 59.5, whichever lasts longer. In addition, the payment amount has to be based on one of the three following IRS-approved methods:

Amortization: Your payment reflects the amortization of your plan’s balance throughout a single or joint life expectancy. Each payment is fixed.
Minimum Distribution: You take your balance and divide it by a certain factor taken from the IRS single or joint life expectancy table. Thus, the amount can vary from year to year.
Annuity Factor Method: You take your IRA account balance and divide it by an annuity factor based on the IRS mortality table and “reasonable” interest rates up to 120% of the mid-term applicable federal rate at the time you make the calculation.

You should talk to a professional to make sure that your unique situation is taken into account.

Hardship Withdrawal for a Roth IRA

Roth IRAs have a little more flexibility when it comes to withdrawals. Unlike employer-sponsored plans like 401(k)s, Roth IRAs don’t technically have “hardship withdrawals” as a formal category, but they do offer flexibility during financial emergencies. The IRS doesn’t specifically define what qualifies as a hardship for Roth IRA purposes, giving account holders more leeway.

One of the most beneficial features of a Roth IRA is that you can withdraw your original contributions at any time without taxes or penalties. Since you’ve already paid taxes on this money before contributing, the IRS allows you to access these funds penalty-free, regardless of your age or how long the account has been open. This makes Roth IRAs particularly valuable during financial emergencies.

While contributions can be withdrawn freely, different rules apply to the earnings portion of your Roth IRA. Typically, withdrawing earnings before age 59½ results in both income taxes and a 10% early withdrawal penalty. However, certain exceptions exist for genuine hardships, including unreimbursed medical expenses exceeding 7.5% of your adjusted gross income, health insurance premiums while unemployed, or costs related to a permanent disability.

Bottom Line

Tapping into your retirement plan in case of emergency should be your last resort but there are plenty of ways to minimize the hit. For instance, you generally can avoid early withdrawal penalties if you use the money to cover a substantial qualified medical or higher education expense. However, you’d still owe income tax on the withdrawal amount any time you take money out of a traditional IRA. You must also report allowable hardship withdrawals on your tax return.

Tips for Managing Your Retirement Savings

A financial advisor can offer valuable advice as you consider whether to make a hardship withdrawal. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Consider your asset allocation, especially as you get closer to retirement. As you age, your portfolio should generally carry less risk. The Rule of 120 is a quick and simple rule of thumb to help you determine how much of your portfolio should be invested in stocks and bonds.