The IRS recently posted the information below…and at about the same time I was helping an unemployed taxpayer save thousands by showing this person how to avoid penalties on an IRA distribution that was used to get through the lean times. So if you're under age 59 1/2* and had to take a pension or IRA distribution last year, or you're considering taking one, make sure to look carefully for all the possible exceptions to the early distribution penalty. There are several ways to get money out of an IRA or pension without penalty even if you're under age 59. I'll give you a few of the more common exceptions, but to find a complete list, start with page 3 of the Form 5329 instructionsor consult with a well-qualified professional. [*If you have an employer-based plan and you're separated from service, you can start taking distributions penalty-free at age 55 instead of 59 1/2.] First, make sure you have a taxable withdrawal. If you've contributed to a Roth IRA, or made non-deductible contributions to a Traditional IRA (or the equivalent employer-based plans), then part or all of your contribution might be tax-free. With Roth IRA distributions, all of your distributions are tax- and penalty-free until you've distributed an amount equal to your contributions to the plan. (If you've converted Traditional IRA money to a Roth, you'll have to wait five years before withdrawing these funds without a penalty.) With Traditional IRAs, the formula is more complicated…basically a portion of your distribution is non-taxable based on the portion of your IRA value that comes from non-deductible contributions. See Form 8606 for the details of that calculation. The amount of your distribution that is tax-free will also be penalty-free. Once you've determined some or all of your distribution is taxable, you'll want to start looking for exceptions to the early withdrawal penalty. Some of the most common ways we find to avoid these penalties relate to education and medical expenses. Unemployed individuals are generally able to avoid the penalty for amounts equal to what they pay for health insurance. And if you had major medical expenses (greater than 7.5% of your income), you may be able to exclude part of these costs from penalty as well. Students are able to avoid the penalty for amounts equal to what they pay for qualified education expenses. And here's a little known twist on education…if you're at least a half-time student, you can include an allowance for room and board in your "qualified education expenses"–even though room and board is usually not considered an education expense for most purposes. Your school's financial aid department should be able to help you determine the official room and board allowance for your school. Some other exceptions exist, and they might be worth looking into depending on how large your penalty might be, but they're unlikely to apply if you took a withdrawal due to financial need. If you're considering a withdrawal, and considering a home purchase, be aware that there's a $10,000 exception for qualified "first-time home buyers" (which includes taxpayers who haven't owned their home in the last two years). This exception can be used by both spouses, so it can be exclude $20,000 from penalty on a joint return. This exception can be used once in your lifetime. Of if you're in your 50′s, you might be able to take advantage of an exception that applies to a series of substantially equal payments made over a series of years. The payments must last at least 5 years or until you reach age 59 1/2, whichever is later, so this requires careful planning. Be aware that some of these exceptions apply to individual retirement accounts like IRAs, some to employer plans like 401k's, and some apply to both types of plans. Before applying any of these exceptions, or taking any action based on the intent of applying any of these exceptions, make sure you do your homework or consult a professional. And without further ado, here's what the IRS had to say on the topic:
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