Sometimes you need to tap into your retirement fund before the IRS prefers you did. Though dipping into these funds is not recommended, we understand that unpredictable situations happen. But, if this is the best option for your circumstance, you will be subject to an early withdrawal penalty (unless you qualify for an exception) on top of typical income taxes. Is this still the right option for you? We’d love to help in any way we can. Here are the rules you’ll need to know when taking an early distribution with your self-directed IRA.
Let's break it down:
What's A Distribution?
An IRA distribution is when you take funds or assets out of a retirement account (either an IRA or a qualified plan) and into your personal possession.
An early distribution is any distribution taken before the account-holder is 59 1/2 years old.
There are 3 main types of distributions:
- An early distribution (also known as a premature distribution) is any distribution taken before the account-holder is 59 1/2 years old.
- A normal distribution is any non-required distribution taken after the account-holder is 59 1/2.
- A required minimum distribution (RMD) is a distribution you must take yearly once you turn 70 1/2 — but only if you have a traditional IRA. Roth IRAs are exempt from this requirement, as you pay taxes on the amount before you contribute.
When Can You Take An IRA Distribution?
You can take a distribution at any time— but the IRS implements a 10% early distribution tax if you are under 59 1/2. Unless you have a Roth IRA (which has slightly different rules), it doesn't matter what type of IRA you have— the early IRA distribution penalty applies across all accounts. If you have a Traditional, SEP, or SIMPLE IRA, you will also be responsible for paying normal taxes on the full amount distributed, as the IRS considers this income. Once you've hit 59 1/2, there is no penalty for distributing your account, but the amount will still count as income— so you'll still be responsible for paying those taxes.
If you have a Roth IRA, it’s not quite the same. After the account has been open for five years, you are able to distribute any of the original contributions (but none of the gains) tax-free, without any penalties.
Exceptions To The Early Distribution Penalty
There are some IRS approved exceptions to the early distribution penalty (though you'll have to apply to the IRS for approval). You may qualify for an exception if any of the following apply:
- You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income, or 10% if under 65.
- The distributions aren't more than the cost of your medical insurance due to a period of unemployment.
- You are totally and permanently disabled.
- You have an inherited IRA, as the beneficiary of a deceased IRA owner.
- You are receiving distributions in the form of an annuity.
- The distributions aren't more than your qualified higher education expenses.
- You use the distributions to buy, build, or rebuild a first home.
- The distribution is due to an IRS levy of the qualified plan.
- The distribution is a qualified reservist distribution.
There are a few other exceptions available as well (you can find out more from the IRS). If you think an exception should apply to you, it is best that you reach out to a tax professional for the appropriate next steps.
How To Take An Early Self-Directed IRA Distribution
The process for an early self-directed IRA distribution is the same for any distribution with IRA Resources. You'll need to submit a completed Distribution Form to start the request. If you are a resident of California, you have the option to withhold your state taxes from the amount distributed. We cannot withhold state taxes for residents of any other state— you will still need to pay these yourself at tax time. Make sure you have correctly filled out each part of the form, as any error could delay your request.
If you are attempting to distribute assets in-kind (meaning without liquidating the asset) there are a few extra steps. You’ll need to fill out our Fair Market Valuation (FMV) Form and provide supporting documentation to support the value of your asset. Our blog on how to properly report fair market valuations provides additional information on valuing your assets and acceptable supporting documents. The penalty is paid during tax time, when you are paying your regular taxes. If you think one of the above exceptions applies, this is when you would make note of this. Please consult with a tax advisor before determining your tax strategy.
- If you don’t need the funds, you can put the money back into the account within 60 days (starting from the date of the original distribution) as a rollover. Please keep in mind that the IRS will only allow you to complete 1 rollover every 12 months. This rule applies for all your retirement accounts.
- Your administrator or custodian does not impose the tax penalties. That is imposed directly from the IRS when you file your taxes.
- Unless an exception applies, your distribution from your administrator or custodian will always be reported to the IRS as an early distribution (if you’re under the age of 59 ½), no matter the reason for the distribution. When you get your 1099R from the IRS, it will indicate your distribution was premature. If not indicated at the time of distribution, it is your job to report the exemption to the IRS when filing your taxes. Please make sure to consult with a qualified tax advisor to ensure that you are filing the necessary documents and forms.
- Please consult with a qualified tax advisor before taking your distribution, so that you are aware of the taxes and penalties that you may have to pay.
When taking an early distribution from your IRA, it's important to keep the realities in mind. The process is simple, even if the choice may not be. You'll need to keep in mind you're responsible for both the income tax and the early distribution penalty of 10% on the amount, unless you qualify for an exception. No matter when or why, IRA Resources is here to make the process easy, every step of the way. If you have any questions about distributions, you can submit a question and a representative will get back to you as quickly as possible. Happy investing!