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An early IRA withdrawal is the act of removing funds from an existing individual retirement account prior to reaching the age of retirement, or at least the calendar age of 59 and ½. When this action is taken, there are often substantial penalties incurred as a result. However, there are two distinct exemptions for early IRA withdrawal activity that are roughly categorized as hardship distributions.
The first type of early IRA withdrawal that can escape tax and other penalties is the school exemption. This has to do with providing higher education for the individual, a spouse, or a child or grandchild. However, simply choosing to use an IRA distribution through withdrawal in order to pay tuition and fees at any college or university is not enough to escape the penalties. There are some qualifications that must be met in order for the early IRA withdrawal to not incur taxes and other damaging penalties.
First, the early IRA withdrawal must be used to attend an educational institution that is considered to be an approved college or university by the Internal Revenue Service. To that end, it is important to make sure the institution currently meets the requirements necessary to receive and administer federal student aid programs. The institution typically has to be recognized as currently accredited as well. Colleges and universities whose accreditation are currently under review or suspended may not qualify. This means an early IRA withdrawal that is used to pay tuition and fees to schools that fail to meet federal student aid program requirements or is not currently accredited will be subject to taxation and penalties.
Second, an early IRA withdrawal may be obtained without penalties if the purpose of the withdrawal is to help purchase a first home. Known as the first home exemption, it is possible to withdraw up to $10,000.00 US Dollars (USD) from an IRA and use the funds as a down payment on a first home. This figure is applicable for each IRA in place. This means that if both spouses currently have their own IRA account, each spouse may withdraw up to $10,000.00 USD from each account. This would result in a total of $20,000.00 USD that could be put toward the purchase of a home without incurring any penalties from the IRS.
As a side note, the first home exemption can be applied to situations involving a close relative. A parent may engage in an early IRA withdrawal in order to assist a child or a grandchild in securing a first home. In like manner, a child may withdraw funds in order to assist a parent in obtaining a home.
In order to avoid penalties associated with an early IRA withdrawal, the funds must be used for a qualified exemption within 120 days after withdrawing the funds. If the exemption is not sought and awarded during this time frame, all normal taxes and penalties will apply. In cases where persons wish to make use of IRA funds for some other purpose, an IRA loan would likely be a better solution.
Is a rollover from my pension to an IRA considered funds from my IRA for the first time home buyer exception?