When Is the Penalty Waived for an IRA Cash-Out?

You'll have to pay extra in penalties on your taxes unless an exception applies.

You'll have to pay extra in penalties on your taxes unless an exception applies.

If you haven't reached age 59 1/2 but you're considering cashing out your individual retirement arrangement, you might be on the hook for an extra 10 percent penalty on top of the taxes you'll owe. If you inherited the IRA, you can cash out your IRA any time, for any reason, without penalty regardless of your age. However, if you're the original owner of the IRA, you need to meet certain criteria or qualify for an exception in order to avoid the penalty.

Nontaxable Distributions

The early withdrawal penalty on IRA distributions applies only to the taxable portion of your distribution. If you're taking a distribution from a Roth IRA, your contributions come out tax-free, so only the earnings are taxable. For example, if you've got $10,000 in contributions in your Roth IRA and you cash out $15,000, the first $10,000 comes out tax-free -- and therefore penalty-free -- and only the last $5,000 is taxable and therefore also subject to the early withdrawal penalty.

Large Medical Expenses

Your early IRA withdrawal may qualify for an exception if you use it for certain medical expenses. These medical expenses would need to qualify as tax-deductible if you itemized them. In 2012, medical expenses that exceed 7.5 percent of your adjusted gross income are deductible, but in 2013, the threshold jumps to 10 percent. For example, suppose in 2013 you have $10,000 in medical expenses and an adjusted gross income of $60,000. You would avoid the early withdrawal penalty on up to $4,000 of your IRA cash-out.

Unemployed Insurance Premiums

The cost of medical insurance premiums for you, your spouse and your dependents while you're unemployed is exempted from the penalty. To qualify, you must have lost your job, received at least 12 weeks of state or federal unemployment benefits, taken the distribution in either the same year you received the unemployment benefits or the following year, and taken the distribution no later than 60 days after getting a new job.


You can avoid the penalty on all of your IRA cash-out if you're permanently disabled. According to IRS Publication 590, you're disabled if you can prove that you can't do any substantial gainful activity because of your condition. Proof generally consists of a doctor determining your condition will result in death or continue indefinitely.

Higher Education Expenses

Distributions used for qualified higher education expenses for yourself, your spouse or your children or grandchild are also exempt from the penalty. Qualified expenses include tuition, fees, supplies and, if the student's enrolled at least half-time, room and board at a post-secondary educational institutions like trade schools, colleges and graduate programs. However, the exception doesn't apply to any costs paid for with tax-free assistance like scholarships or Pell grants.

First-Time Homebuyer

If you're a first-time homebuyer, you can avoid the penalty on up to $10,000 of distributions used for homebuying costs, which include buying the home and finance charges. You're a first-time homebuyer if both you and your spouse haven't owned a home for the past two years. The exception is limited to only $10,000 over your lifetime, so if you use it all for your own first home, you can't use the exception to help your kids buy a first home. However, it applies separately to each spouse, so if your husband had previously used his exception, you still have yours.

Qualified Reservist Distributions

If you were in the armed forces reserves and you were called up to duty, you might be able to waive the penalty. To qualify, you have to be called to active duty after Sept. 11, 2001, and be on active duty for at least 180 days. The distribution was made between the time you were called to active duty and the end of your active duty period.

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About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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