Tax-deferred accounts like a traditional IRA come with a caveat: strict rules for distributions, both before and after retirement.
Take a withdrawal from your account before age 59½ and you may be hit with a 10% early distribution penalty. Once you hit age 70½, the opposite is true: Traditional IRAs are subject to required minimum distributions. You’re penalized if you don’t withdraw a set amount each year.
Traditional IRA early withdrawal rules
Under traditional IRA distribution rules, withdrawals taken before age 59½ will be taxed and penalized 10%. While you can’t avoid taxes on a traditional deductible IRA distribution — no matter when you take it — there are exceptions that skirt the 10% early withdrawal penalty. (Note that Roth IRA rules are different. If you have a Roth IRA rather than a traditional IRA, you’ll want to follow the Roth distribution guidelines instead.)
Quick nag: Money you’ve saved for retirement should be used for retirement. You’ve heard the expression “robbing Peter to pay Paul”; here, you’re robbing future you to pay present you. Don’t use your IRA as an emergency fund, but do know that if you’re in a true bind, meeting these exceptions will save you the cost of what could be a relatively expensive slap on the wrist.
Qualified higher education expenses
You can use traditional IRA money to pay for higher education expenses not only for yourself, but also for immediate family members (your spouse, children and grandchildren). There is no dollar limit, and expenses that fall under this rule include tuition, fees, books and supplies. Room and board is also allowed for students who are attending more than half time.
You can use up to $10,000 from your traditional IRA toward the purchase of your first home — and if you’re purchasing with a spouse, that goes for each of you.
The IRS’ definition of first home is pretty loose: You’re considered a first-time homebuyer under this rule if you or your spouse haven’t owned a principal residence in the last two years. You must use the money within 120 days of the distribution, so time your withdrawal carefully.
If you’re feeling generous, you can also use this exception to purchase the first home for your or a spouse’s child, grandchild, parent or other ancestor.
Medical expenses and health insurance premiums
You’re allowed a distribution to pay for unreimbursed medical expenses that exceed 7.5% of your adjusted gross income, or to pay for health insurance premiums for you, your spouse or children when you are unemployed.
A couple of things to note here: Traditional IRA money can be used to pay for the portion of the medical expenses that tops 7.5% of your adjusted gross income, meaning if you make $100,000 and have $15,000 in unreimbursed medical costs, you can use IRA assets to pay for $7,500 of it. For the health insurance during unemployment exception, you must take the distributions no more than 60 days after you’ve gotten a new job.
Substantially equal payments
You don’t have to pay the 10% penalty if you start a series of distributions from your IRA that are spread equally over your life expectancy or the life expectancies of you and your account beneficiaries. The fine print: If you turn this fire hose on, you can’t turn it back off — you must take at least one distribution each year, and you can’t modify the schedule of payments until five years have passed or you’ve reached age 59½, whichever is later.
The amount of the distributions must be based on an IRS-approved calculation that involves your life expectancy, your account balance and interest rates.
Qualified reservist distributions
If you’re in the military and you are called to active duty for more than 179 days, you can take a penalty-free distribution from your IRA. The withdrawal must be made during the period of active duty; in other words, you can’t take it earlier than the date of the call to serve, or later than the close of the active duty period.
Death or total and permanent disability
The IRS is stingy about access to IRA cash, but it isn’t unreasonable. If you become disabled, you can tap traditional IRA funds without penalty. If you die, your account beneficiary or estate will be able to do so.
Traditional IRA required minimum distribution rules
The IRS will let you defer taxes for only so long — when you reach age 70½, it starts itching to get its money. It gives you a shove in the form of required minimum distributions, which must begin by April 1 of the year following the year when you turn 70½.
You must continue to take distributions for each year by Dec. 31. That means you could end up taking a double distribution the first year — one if you wait till the calendar year after turning 70½ to start by the April 1 deadline, the second by the following Dec. 31. If you don’t take your RMDs on time, you’ll pay a stiff penalty of 50% on the amount not withdrawn.
The amount of the distribution is calculated by dividing your account balance by a life expectancy factor published by the IRS here. You can always elect to take more than the RMD, but keep in mind that traditional IRA distributions are taxed as income.
Finally, if you’re between 59½ and 70½, you’re in that sweet spot when you can do what you want — you don’t have to take distributions from the account, and leaving that money as is will allow it to continue to grow tax-deferred. If you do want to begin distributions, you can. You’ll pay taxes, but no penalty.