Don’t be a Quick IRA Draw: Avoiding a tax penalty

tax penalty

In this piece, Investopedia takes a look at how much you will pay in taxes on an IRA and the different scenarios that apply.

 

Several financial planners chime in on tax-free withdrawals and ways to avoid penalties. Here was my advice:

Ways to Avoid the Early-Withdrawal Tax Penalty

 

There are some hardship exceptions to being charged a penalty for withdrawing money before you reach 59½ from a traditional IRA or the investment portion of a Roth IRA. Some common exceptions (for you or your estate) include:

  • After the death of the IRA owner
  • Total and permanent disability of the IRA owner
  • Required distribution as part of a domestic relations order (divorce)
  • Qualified education expenses
  • Qualified first-time home purchase
  • An IRA’s levy on the plan
  • Unreimbursed medical expenses
  • A call to duty of a military reservist

 

One other way to escape the tax penalty: If you make an IRA deposit and change your mind by the extended due date of that year’s tax return, you can withdraw it without owing the penalty. (Of course, that cash will be added to the year’s taxable income.)

 

The other time you risk a tax penalty for early withdrawal is when you are rolling over the money from one IRA into another qualified IRA. The safest way to accomplish this goal is to work with your IRA trustee to arrange a trustee-to-trustee rollover. If you make a mistake trying to roll over the money without the help of a trustee, you could end up owing taxes. “Most plans allow you to put the name, address and your account number of the receiving institution on their rollover forms. That way, you never have to touch the money or run the risk of paying taxes on an accidental early distribution,” says Kristi Sullivan, CFP®, Sullivan Financial Planning, LLC, Denver, Colo.

 

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