Considering an Early Withdrawal from IRA Here's Ways You Can Avoid Penalty

The COVID-19 pandemic has disembogued an array of financial difficulties on people. The economy has suffered, businesses have shuttered and people are dealing with severe pay cuts and job losses. Amidst this crisis, many people facing a shortfall of cash have turned to IRA to pay their bills and rent.

Typically, an early withdrawal from the IRS (before you reach age 59½) attracts a 10% penalty and is subject to income taxes. The taxable percentage depends on whether you’ve made any nondeductible contributions to the account. There are exceptions, of course, such as paying for higher education costs or medical expenses.

New Exceptions

There is some relief for those looking for early withdrawal from the IRA. Under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, an exception has been added where a withdrawal from your retirement plan allows you to pay the taxes over three years. Additionally, if you can repay the fund within these three years, you would be exempted from taxes.

The IRS has extended this provision to cover those suffering from COVID-19, laid off or furloughed during the pandemic, entrepreneurs or small business owners who closed down their businesses, or a spouse or dependent family member of the same. Anyone qualifying as per the above requirements is eligible for a $100,000 distribution.

Substantially Equal Periodic Payments (SEPP)

SEPP is a method of distributing specific annual funds from an IRA or other qualified retirement plans before the age of 59½ without running into penalties. The amount that can be withdrawn every year is decided as per IRA's set formulas. SEPP can only be availed for five years or before the withdrawer hits the age of 59½, whichever comes earlier.

SEPP is ruled by a fairly complicated set of rules and guidelines, hence it is best to use it as a last resort. Moreover, if you are going to opt for a SEPP plan, it is best to consult a professional accounting firm to assist and advise you on the same. Ideally, SEPP is best suited for those whose careers have ended early due to various reasons, and they don't see a new source of income coming in the future. A major downside of opting for the SEPP plan is that if the account holder quits the plan before it ends, they are obliged to pay the penalties avoided as part of the plan's benefits.

Expenses of Exception

As discussed above, early withdrawals made from the IRA for certain expenses are exempt from penalties and taxes.

First-time home purchasers or their immediate kin (spouse, child, grandchild, or grandparent) can avail of a penalty-free and tax-free early withdrawal for qualified acquisition costs. Qualified acquisition costs are costs required to acquire, construct, or reconstruct a principal residence. One of the most critical requirements of this exemption is that the buyer must not have owned a principal property within the last two years.

Account owners can also withdraw the money to pay for higher education expenses of their own, their child, grandchild, spouse, stepchild, or adopted child.

Another exemption that has gathered excessive momentum in the wake of COVID-19 is the health insurance exemption. One important condition that has to be met to avail of this exemption is that the account holder has to have received unemployment compensation payments for 12 consecutive weeks. For the year that these unemployment benefits have been claimed, the IRA owner can withdraw funds from their IRA account without attracting any penalties.

The Bottomline

Withdrawing money from your IRS account is always a plausible option, but it should be done very wisely. Before going for it though, know what you are getting into. While the CARES act waives off the penalty, you still have to pay the pertaining taxes for early withdrawal, albeit over a period of three years. For other ways you can avoid penalties too, you must consider the tax implications. Moreover, do not forget that your IRS account is like your retirement fund. An early withdrawal should always be considered only after all options are exhausted.

If you are considering an early IRA withdrawal or are looking to explore more options to meet the pandemic income crunch, our professionals at AAABSI are here to help you. With years of experience and expertise behind us, we look out for the best solution for your needs. Get in touch with us now, and our professionals would be glad to assist you.