Few literary quotes ring truer than “The best-laid plans of mice and men often go awry” from Robert Burns’ poem, “To a Mouse.”
No matter how careful your blueprint, life occasionally will get in the way, forcing you to adapt. You plan to have children the old-fashioned way but are thwarted by biology; you pivot to a pricey adoption. You diligently save for a down payment on a home but a family member racks up costly medical bills; you might dig into those savings to help out instead. You might have intended to retire at 65 but become unable to work at age 60; you decide you must retire early.
In all of these cases (and in many other situations), you could probably use a one-time influx of cash—like, say, pulling money from a retirement account. Fortunately, the rules governing 401(k)s, individual retirement accounts (IRAs), and other vehicles have accounted for these situations—so while they all have rules demanding hefty penalties for early withdrawals, numerous exceptions exist.
Today, I’m going to show you some of the most common exceptions to early-withdrawal penalties. If you belong to one of these groups of people, you may be able to dig into your retirement account to alleviate your situation without being penalized.
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The information and analysis contained within this article appears for your consideration, but it does not constitute individualized financial advice. Always act at your own discretion.
These People Can Make Penalty-Free Early Retirement Account Withdrawals
The early withdrawal penalty for virtually all retirement accounts is 10% of the withdrawn amount. So if you were to withdraw $10,000, you would have to pay an additional $1,000 as an early withdrawal penalty.
There are few exceptions to this 10% figure, though a few exist. For instance, early withdrawals within the first two years of participation in a SIMPLE IRA will result in a 25% penalty.
You’ll generally calculate early retirement penalties or claim exceptions on IRS Form 5329, which you’ll include in your annual tax filing. Your financial institution should also report the distribution on Form 1099-R. You’ll also need to include the penalty on Schedule 2, which you’ll attach to your Form 1040.
Importantly, this 10% penalty is in addition to income taxes. If you withdraw money from a retirement account, you will almost always have to pay income taxes based on your federal tax rate. (The most common exception: Contributions to a Roth IRA can be withdrawn tax- and penalty-free at any time for any reason.)
However, retirement accounts have many built-in exceptions for the early withdrawal penalty. Let’s look at some of the most common groups of people who can skip the 10% fine for withdrawing before the minimum age threshold (generally 59½) for penalty-free distributions. Note that regular taxes will still apply in all situations unless otherwise specified.
1. First-Time Homebuyers
Qualified first-time homebuyers can get a little help to make their homeownership dream come true.
Specifically, they can withdraw up to $10,000 penalty-free from certain types of retirement accounts, including IRAs, Roth IRAs, Simplified Employee Pensions (SEPs), Savings Incentive Match PLan for Employees (SIMPLE) IRAs, and Salary Reduction Simplified Employee Pension (SARSEP) plans.
Roth IRAs have an added bonus: If your account has been open for five years or more, your earnings will be subject to neither the penalty nor taxes.
However, this is one of only a few exceptions that are not available to certain qualified workplace plans, most notably 401(k)s.
Do you want to get serious about saving and planning for retirement? Sign up for Retire With Riley, Young and the Invested’s free retirement planning newsletter.
2. People Eligible for the Rule of 55
The Rule of 55 lets eligible people begin taking distributions from their 401(k), 403(b), or other qualified workplace plan without the early withdrawal penalty if they lose or leave their job during or after the calendar year in which they turn 55.
Importantly, though, penalty-free withdrawals only apply to the account the person was contributing to when they leave that job. That said, you can still use the Rule of 55 even if you’re seeking new employment.
Lastly, public safety employees (corrections officers and federal firefighters, for example) can start taking penalty-free withdrawals using the rule as early as the calendar year in which they turn 50.
Related: Want to Retire Early? Don’t Make These Mistakes
3. People Eligible for Rule 72(t)
Rule 72(t) refers to a specific part of Internal Revenue Code section 72(t), specifically, Section 72(t)(2)(A)(iv). There, it states that anyone can skip the 10% early withdrawal penalty if they take a minimum of five substantial equal periodic payments (SEPPs) or follow the payment schedule until age 59 ½, whichever is longer.
Importantly, payments have to be withdrawn on a specific schedule, based on one of three allowed calculation methods of your choice, which we outline in our primer on Rule 72(t). You can’t adjust the SEPP amounts, nor can you make additional withdrawals; doing so would subject you to the 10% penalty you’re trying to avoid. Additionally, once withdrawals begin, a person can’t contribute more money.
Virtually all workplace and personal retirement plans are eligible for Rule 72(t) withdrawals.
Related: Rule of 55 vs Rule 72(t): What’s the Difference?
4. Unemployed People Who Need Health Insurance
Unemployed people who need health insurance get a break, too.
One of your top priorities after a layoff (or becoming unemployed for another reason) should be to prevent a health coverage gap. While I wouldn’t necessarily recommend dipping into your retirement savings as a Plan A, it’s an option if you need it—for certain plans, anyways.
You can take distributions for the amount paid for family health insurance premiums if you were unemployed for at least 12 weeks and received unemployment compensation in the year of the distribution or the subsequent year.
IRAs, Roth IRAs, SEPs, SIMPLE IRAs, and SARSEPs are eligible for this withdrawal exception. Qualified retirement plans, such as 401(k)s and 403(b)s, are not.
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Related: Should You Tap Into Retirement Savings After a Layoff?
5. Domestic Abuse Victims
In addition to causing emotional, and possibly physical issues, domestic abuse can cause financial struggles as well.
Those who experience domestic abuse from a spouse or domestic partner may take distributions up to the lesser of $10,000 or 50% of the account, penalty-free, from both qualified workplace accounts and individual retirement plans.
Related: Medicare FAQs: Your Questions Answered
6. People With Total and Permanent Disabilities
Some disabilities can limit or eliminate your ability to work, and they can also lower a person’s life expectancy. For either reason, or both, those with disabilities may want to start taking retirement withdrawals early.
Retirement account owners with total and permanent disabilities can take early withdrawals penalty-free, with no limit, from qualified workplace accounts and individual accounts alike.
To qualify for this exception, you must meet the IRS’s definition of “permanently and totally disabled,” which requires both of the following to apply: You can’t engage in any substantial gainful activity because of a physical or mental condition, and a physician determines the disability has lasted or can be expected to last continuously for at least a year or can lead to death.
Related: 10 Discounted Memberships + Subscriptions for Seniors
7. Natural Disaster Victims
If you suffer economic loss from a federally declared disaster that occurs where you reside, you may be eligible for a penalty-free withdrawal.
This exception applies for up to $22,000 in withdrawals, and it applies to both workplace and individual retirement plans.
Related: 12 Income Sources That Don’t Affect Your Social Security Benefits
8. New Parents
Are you a new parent? You’re almost certainly swimming in a few high bills right now.
Thankfully, Americans with virtually any type of retirement plan who have a new child—whether by birth or adoption—can take penalty-free distributions of up to $5,000 per child to cover qualified birth or adoption costs.
Related: 10 Pros + Cons of Pets During Retirement
9. People With Certain Emergency Expenses
When a personal or family emergency strikes, it’s a good time to dip into one’s emergency fund. Unfortunately, several emergencies may pop up in a short amount of time and deplete your savings.
Related: 8 Ways Travel Can Be More Expensive for Senior Citizens
You do have another backstop—your retirement plan—but it’s modest.
Specifically, you can withdraw up to the lesser of $1,000 or a vested account balance to cover personal or family emergency expenses. And you can only make one distribution per calendar year.
Do you want to get serious about saving and planning for retirement? Sign up for Retire With Riley, Young and the Invested’s free retirement planning newsletter.
10. College Students
Another group that’s exempted from the 10% additional tax on early distributions is students with qualified higher education expenses.
Qualified education expenses can include the following:
- Tuition
- Fees
- Books
- Supplies and equipment required for the enrollment or attendance of the student
- Expenses for special needs services
- Room and board (only if at least half-time student)
The amounts withdrawn can’t exceed the qualified expenses paid during the year. Also, this type of distribution can only be taken from IRAs, Roth IRAs, SIMPLE IRAs, and the like, but not qualified workplace plans.
Related: How Much Should You Financially Support Adult Children?
