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Yes, but the taxable portion of your distribution may be subject to a 10% penalty for early withdrawal if you’re not yet age 59½. If you are 59½ or older and take money from your traditional IRA, you will not be assessed a penalty, though you may still have to pay income tax on all or part of the distribution. The purpose of the premature distribution tax is to discourage you from exhausting your IRA savings too soon. However, the penalty can be a significant drawback if you need money to meet unexpected expenses.
If you are experiencing a cash crunch, it’s usually better to draw on other investments before dipping into your IRA. However, if your IRA is your only sizable asset, you may have no choice. If that’s the case, be aware that there are a number of exceptions to the premature distribution rule.
If you are disabled, you are exempt from the penalty, as long as you meet the IRS definition of disability. If an IRA owner dies before reaching age 59½, and you are a beneficiary of the account, distributions that you receive are exempt. If you need supplementary income, you can take IRA distributions as a series of “substantially equal payments” over your life expectancy or the joint life expectancy of you and your beneficiary. These distributions may avoid the penalty as long as you don’t modify the payments within certain time frames.
Subject to limits and conditions, the penalty tax generally will not apply to IRA distributions taken to pay qualifying medical expenses, health insurance premiums while you’re unemployed, higher education costs, costs associated with the birth or adoption of a child (up to $5,000), and qualified first-time home-buyer expenses (up to $10,000 lifetime from all your IRAs). It also does not apply to amounts rolled over from one IRA to another (assuming you follow the rules for rollovers), to conversions of traditional IRAs to Roth IRAs, to amounts that the IRS levies from your IRA to cover your tax bill, or to qualified reservist distributions. Other exceptions may also apply.
Due to the Coronavirus Aid, Relief, and Economic Security (CARES) Act, penalty-free withdrawals of up to $100,000 will be allowed in 2020 for qualified individuals affected by COVID-19. Individuals will be able to spread the associated income over three years for income tax purposes and will have up to three years to reinvest withdrawn amounts.
Qualified distributions from your Roth IRAs are federal income tax — and penalty tax — free. Distributions are qualified if you satisfy a five-year holding period, and you are (a) age 59½, (b) disabled, (c) deceased, or (d) you have qualified first time home-buyer expenses. The taxable portion of nonqualified distributions from your Roth IRAs is subject to the same 10% penalty rules that apply to traditional IRAs. (Special rules may apply if you take a nonqualified distribution from your Roth IRA within five years of a conversion.)
Finally, education IRAs may be subject to special rules of their own.
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Prepared by Broadridge Investor Communication Solutions, Copyright 2020.
SESLOC Wealth Management is provided through our relationship with CUSO Financial Services, L.P. (CFS)* an Independent Broker-Dealer and SEC Registered Advisor formed for the express purpose of serving Credit Union member’ investment and financial planning needs.
*Non-deposit investment products and services are offered through CUSO Financial Services, L.P. (“CFS”), a registered broker-dealer (Member FINRA/SIPC) and SEC Registered Investment Advisor. Products offered through CFS adre not NCUA/NCUSIF or otherwise federally insured, are not guarantees or obligations of the credit union, and may involve investment risk including potential loss of principal. Investment Representatives are registered through CFS. SESLOC has contracted with CFS to make non-deposit investment products and services available to credit union members. CFS and its representatives do not provide tax advice. For specific tax advice, please consult a qualified tax professional.