Exceptions to the 10% Early Withdrawal Penalty for IRA Distributions
Taking money from your IRA before age 59½? Normally, that means a 10% penalty on top of income tax—but there are exceptions.
In this article, we break down the most common situations where the IRS waives the early withdrawal penalty on IRA distributions. From first-time home purchases and higher education to medical expenses and unemployment, we walk through what qualifies and what to watch out for.
When distributions are processed from an IRA account prior to age 59½, the IRS generally assesses a 10% early withdrawal penalty in addition to the ordinary income taxes owed on the amount of the distribution.
However, as with most aspects of the tax code, there are exceptions.
Whether you’re facing a financial emergency or considering strategic planning options, it’s essential to understand the legitimate circumstances under which the IRS waives the early withdrawal penalty. In this article, we’ll walk through the most common exceptions to the 10% penalty and provide some guidance on how to navigate them.
The Basics: Tax vs. Penalty
First, a quick clarification:
When you take a distribution from a traditional IRA, you generally owe ordinary income tax on the amount withdrawn. That’s true whether you’re 40 or 70. The 10% early withdrawal penalty is in addition to that tax and is designed to discourage people from prematurely accessing their retirement funds.
However, the IRS carves out several exceptions for situations it deems reasonable or necessary. These exceptions waive the penalty, not the income tax (unless otherwise noted).
Key Exceptions to the 10% Early Withdrawal Penalty
Here are the most common exceptions that apply to IRA distributions:
1. First-Time Home Purchase
One of the more well-known exceptions to the 10% early withdrawal penalty is for a first-time home purchase. The IRS allows you to take up to $10,000 from your traditional IRA—penalty-free—to put toward buying, building, or rebuilding your first home. If you’re married, both spouses can each take $10,000 from their respective IRAs for a combined total of $20,000.
Now, the term “first-time homebuyer” is a bit misleading. You don’t have to be a literal first-time buyer—you just have to not have owned a primary residence in the last two years. That opens the door for people re-entering the housing market after renting, relocating, or going through a divorce.
2. Qualified Higher Education Expenses
Tuition, fees, books, supplies, and required equipment for you, your spouse, children, or grandchildren all qualify. Room and board also qualify if the student is enrolled at least half-time.
Planning tip: If you're considering this, remember that using retirement funds for education can impact long-term growth. Exhaust other education savings options first.
3. Disability
If you become totally and permanently disabled, you can take distributions at any age without penalty. The burden of proof here is high—the IRS requires documentation from a physician.
4. Substantially Equal Periodic Payments (SEPP)
This is a strategy where you take consistent withdrawals based on your life expectancy. You must commit to this withdrawal strategy for at least 5 years or until you reach age 59½, whichever is longer.
Strategy note: SEPPs can be complex and restrictive. It’s a tool best used under close guidance from a financial advisor or CPA.
5. Unreimbursed Medical Expenses
If you have unreimbursed medical expenses that exceed 7.5% of your adjusted gross income (AGI), you can withdraw IRA funds penalty-free to cover that portion.
6. Health Insurance Premiums While Unemployed
If you’ve lost your job and received unemployment compensation for at least 12 consecutive weeks, you can use IRA funds to pay for health insurance premiums for yourself, your spouse, and dependents without triggering the penalty.
7. Death
If the IRA owner dies, the beneficiaries can take distributions from the inherited IRA without facing the 10% penalty, regardless of their age.
8. IRS Levy
If the IRS issues a levy directly on your IRA, you won’t face the penalty. Voluntary payments to the IRS, however, don’t qualify.
9. Qualified Birth or Adoption
You can withdraw up to $5,000 per child within one year of the birth or adoption without penalty. This is a relatively new provision under the SECURE Act and gives new parents a bit more flexibility.
Important Caveats
Roth IRAs have their own set of rules. Since contributions to a Roth are made with after-tax dollars, you can withdraw your contributions (not earnings) at any time, for any reason, without tax or penalty.
These 10% early withdrawal exceptions apply to IRAs, not necessarily to 401(k)s, which have a slightly different set of rules (though some overlap).
Final Thoughts
While these exceptions can be life-savers in times of need, early IRA withdrawals should still be a last resort for most people. The long-term cost in lost compounding and retirement security can be substantial.
That said, life doesn’t always go according to plan. Knowing your options—and using them strategically—can help you make informed, tax-efficient decisions when circumstances require flexibility.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
Frequently Asked Questions (FAQs):
What is the 10% early withdrawal penalty on IRA distributions?
If you withdraw money from a traditional IRA before age 59½, the IRS typically charges a 10% penalty in addition to ordinary income taxes owed on the amount withdrawn.
Are there exceptions to the 10% penalty?
Yes. The IRS waives the early withdrawal penalty for specific circumstances such as:
First-time home purchase (up to $10,000)
Qualified higher education expenses
Total and permanent disability
Unreimbursed medical expenses exceeding 7.5% of AGI
Health insurance premiums while unemployed
Can I use IRA funds for a first-time home purchase without penalty?
Yes. You can withdraw up to $10,000 ($20,000 for couples) penalty-free to buy, build, or rebuild a first home. You qualify as a “first-time buyer” if you haven’t owned a primary residence in the past two years.
Are college costs or medical expenses penalty-free?
Yes. You can withdraw IRA funds penalty-free for qualified education costs for yourself, your spouse, children, or grandchildren. You can also avoid the penalty if you use funds to pay unreimbursed medical bills that exceed 7.5% of your AGI.
Do these exceptions eliminate income taxes too?
No. The 10% penalty may be waived, but standard income tax on traditional IRA withdrawals still applies unless it’s a Roth IRA contribution being withdrawn.
How Does A SEP IRA Work?
SEP stands for “Simplified Employee Pension”. The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.
What is a SEP?
SEP stands for “Simplified Employee Pension”. The SEP IRA is one of the most common employer sponsored retirement plans used by sole proprietors and small businesses.
Special Establishment Deadline
SEP are one of the few retirement plans that can be established after December 31st which make them a powerful tax tool. For example, it’s March, you are meeting with your accountant and they deliver the bad news that you have a big tax bill that is due. You can setup the SEP IRA any time to your tax filing date PLUS extension, fund it, and capture the tax deduction.
Easy to Setup & Low Plan Fees
The other advantage of SEP IRA’s is they are easy to setup and you do not have a third-party administrator to run the plan, so the costs are a lot lower than a traditional 401(k) plans. These plans can typically be setup with 24 hours.
Contributions limits
SEP IRA contributions are expressed as a percentage of compensation. The maximum contribution is either 20% of the owners “net earned income” or 25% of the owners W2 wages. It all depends on how your business is incorporated. You have the option to contribution any amount less than the maximum contribution.
100% Employer Funded
SEP IRA plans are 100% employer funded meaning there is no employee deferral piece. Which makes them expense plans to sponsor for a company that eligible employees because the employer contribution is uniform for all employees. Meaning if the owner contributes 20% of their compensation to the plan for themselves they must also make a contribution equal to 20% of compensation for each eligible employee. Typically, once employees begin becoming eligible for the plan, a company will terminate the SEP IRA and replace it with either a Simple IRA or 401(k) plans.
Employee Eligibility Requirements
An employee earns a “year of service” for each calendar year that they earn $500 in compensation. You can see how easy it is to earn a “year of service” in these types of plans. This is where a lot of companies make an error because they only look at their “full time employees” as eligible. The good news for business owners is you can keep employees out of the plan for 3 years and then they become eligible in the 4th year of employment. For example, I am a sole proprietor and I hire my first employee, if my plan document is written correctly, I can keep that employee out of the SEP IRA for 3 years and then they will not be eligible for the employer contribution until the 4th year of employment.
Read This……..Very Important…..
There is a plan document called a 5305 SEP form that is required to sponsor a SEP IRA plan. This form can be printed off the IRS website or is sometimes provide by the investment platform for your plan. Remember, SEP IRA plans are “self-administered” meaning that you as the business owner are responsible for keeping the plan in compliance. Do cannot always rely on your investment advisor or accountant to help you with your SEP IRA plan. You should have a 5305 SEP for in your employer files for each year you have sponsored the plan. This form does not get filed with the IRS or DOL but rather is just kept in your employer files in the case of an audit. You are required to give this form to all employees of the company each year. It’s a way of notifying your employees that the plan exists and it lists the eligibility requirements.
Compliance Issues
The main compliance issues to watch out for with these plan is not having that 5305 SEP Form for each year the plan has been sponsored, not accurately identifying eligible employees, and miscalculating your “net earned income” for the max SEP IRA contribution.
About Michael……...
Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.
