About half of all U.S. workers take money out of their retirement fund when changing jobs. However, many people do not realize that the money you withdraw from your IRA retirement fund before you reach the age of 59½ is taxed. It can even be subject to an early withdrawal penalty fee. This is because the money you withdraw from your retirement plan before reaching the age of 59½ is considered an early distribution. Generally, early retirement distributions come with a 10% tax, and you will need to plan accordingly.
Thankfully, there are some exceptions to the rule. Certain circumstances can exempt you from early retirement distribution taxes. Knowing these exemptions can help you efficiently plan for early retirement and the taxes that may come with it.
5 common exemptions people should keep in mind during early retirement planning
Early distribution taxes can cause you to pay a lot more than originally planned. However, if you are planning on withdrawing money from your retirement fund for any of the following reasons, you may be exempt from the 10% early distribution penalty:
- For higher education — Early distributions from your IRA are tax-exempt when used for higher education. Whether you, your spouse or your children are using this money to make payments to a qualified institution, you are exempt from the 10% tax penalty. You can use this money toward tuition, books, room and board, and more.
- In the case of disability — If you have become disabled since the start of your retirement account, you can plan for early distribution tax exemption. You are tax-exempt if you are permanently disabled, and you can use the funds toward supplies, medical bills, rent and other costs.
- For medical costs — If your medical costs are more than 7.5% of your gross income, you may qualify for an early distribution tax exemption to help pay for your medical bills.
- For a first-time home purchase — If you have never bought a home and need money for a down payment to buy your first home, you can withdraw money from your retirement fund and avoid the 10% penalty. Both you and your spouse can each take out up to $10,000 and use it toward buying or building a first home for yourself or a family member.
- If you take out five regular payments — If you do not qualify for any of the above tax exemption situations, you may still be able to withdraw money from your retirement fund before you have reached the age of 59½. To do so, you have to withdraw a set amount of payments each year based on your life expectancy. You must commit to your withdrawal schedule for a minimum of five years, or until you reach age 59½, whichever is longer. If you do not follow these rules, all your early distributions may be subject to the penalty tax.
Talk to a ProVise CFP® professional about planning your early retirement tax exemptions
Ready to start planning for early retirement and related taxes? At ProVise Management Group, our CERTIFIED FINANCIAL PLANNER™ professionals can get to know you and your current financial circumstances, goals, risk tolerance and personal values to help you develop a plan that works for you. We can also create a written plan for you at a fiduciary standard of care. All our written plans come with an unconditional money-back guarantee. If you are unhappy with your written plan, you can return it to us, and we will refund 100% of the fee paid.
Are you ready to talk to a professional about early retirement? Contact ProVise today to schedule a complimentary consultation.