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Breaking Free from Retirement Tax Traps: How to Make Your Money Work for You NOW!

Are you considering an early withdrawal from your retirement account and concerned about potential penalties? Hold on! If you're under the age of 59 1/2, be prepared to face a 10 percent penalty tax on early withdrawals. This is in addition to the regular income tax you'll need to pay when withdrawing money from tax-deferred accounts such as traditional IRAs and 401(k)s. However, fear not! There are ways to navigate these waters and avoid those hefty penalties.


The 10 Percent Penalty Tax: An Overview

The 10 percent penalty tax applies not only to tax-deferred retirement accounts but also to Roth IRAs. However, with Roth IRAs, the penalty applies only to withdrawals of earnings, not contributions. If you've held the Roth account for over five years, withdrawals are not subject to regular income tax.


The Good News: Penalty-Free Withdrawal Exceptions

The SECURE 2.0 Act has introduced more ways to withdraw money from retirement accounts penalty-free. Before diving into these new options, let's explore the key exceptions that were already in place and remain relevant.


1. Taking the Money: Substantially Equal Periodic Payments (SEPPs)

A little-known exception allows penalty-free withdrawals just because you want the money. By taking SEPPs over time, you can supplement your income until you start receiving Social Security or other retirement benefits. No specific purpose or eligibility criteria are required, and there are no age restrictions.


2. Disability

If you become totally and permanently disabled before age 59 1/2, you can make penalty-free withdrawals. A doctor must determine that your condition is expected to result in death or have a long, continuous, and indefinite duration.

3. Medical Expenses

Withdrawals for unreimbursed medical expenses exceeding 7.5 percent of your adjusted gross income are penalty-free. The expenses must be paid during the same calendar year as the withdrawal.


4. Leaving Your Job

No penalty tax on money distributed from a qualified plan if you leave your job the year you turn 55 or later (age 50 for qualified public safety employees).


5. Death

Inherited accounts are not subject to the 10 percent penalty tax, and spouses can roll over the money tax-free.


6. IRS Levies on Your IRA

If the IRS levies on your IRA or qualified plan, no penalty is applied on the levied amount.


7. Birth or Adoption Expenses

Withdraw up to $5,000 penalty-free for birth or adoption expenses per child.


Other Exceptions

Additional exceptions include distributions to qualified military reservists, certain disaster or pandemic-related distributions, and payments under a qualified domestic relations order.


Penalty-Free Withdrawals from IRAs Only

Exceptions exclusive to IRAs:

First-Time Homebuyer: Withdraw up to $10,000 for a first home purchase, applicable to yourself, children, grandchildren, or ancestors. Lifetime limit, used within 120 days.

Unemployed with Medical Insurance: Penalty-free IRA withdrawals if unemployed and receiving unemployment insurance for at least 12 weeks, including self-employed individuals.

Higher Education Expenses: Penalty-free withdrawals for qualified higher-education expenses.

Key Takeaways

1. Beware the 10 Percent Penalty: Early withdrawals usually incur a 10 percent penalty tax, but numerous exceptions exist.

2. Job Departure After 55: No penalty for early withdrawals from a 401(k) or qualified plan if you leave your job after age 55.

3. SEPPs for IRA Withdrawals: Take substantially equal periodic payments for at least five years or until age 59 1/2 for penalty-free IRA withdrawals.

4. Disability Exemption: Penalty-free withdrawals if you become disabled before age 59 1/2.

5. Diverse Reasons for Penalty-Free Withdrawals: Explore options such as purchasing a first home, covering medical expenses, higher education costs, adoption expenses, or handling IRS levies on your IRA.


Understanding these exceptions can empower you to make informed decisions about your retirement accounts, ensuring you avoid unnecessary penalties and secure your financial future. Always consult with a financial advisor to tailor strategies to your specific circumstances.


Disclaimer: Laws and regulations are subject to change, and readers are advised to consult EPL advisors for personalized advice and compliance with specific state requirements. This information is not specific advice and is meant for general education.

You can reach our CEO and founder Peter Ellefson anytime at Peter@eplfs.com



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