Another quick, tax season reminder: If you have experienced a medical emergency, are struggling with chronic medical expenses, or are otherwise struggling to climb out from underneath a mountain of medical-related debt, you may have considered making a withdrawal from your 401(k), IRA or other qualified retirement plan, but been concerned about what penalties you may face for making an early withdrawal.
Okay, first the good news. Yes, you can make an early withdrawal to pay for medical expenses and under certain specific circumstances; you can avoid the tax penalties as well. If you are seriously considering making an early withdrawal to pay for medical expenses, be sure to consult with a tax professional so you can be sure to avoid as many penalties and other pitfalls as you can.
In the meantime, here are some things to consider before you make an early withdrawal from your retirement account:
Early Withdrawals and Taxable Income
Generally, all distributions from an IRA, 401(k) or other retirement plan must be included as part of your taxable income. In addition, withdrawals from a retirement account may be subject to an additional tax of 10% if the distribution is made before you reach age 59 1/2 years old.
To be absolutely clear, this 10% is in addition to your regular income taxes. This additional tax (usually referred to as an early withdrawal penalty) may be avoided if you meet certain criteria, but you cannot avoid including your withdrawal in your taxable income for the year and paying appropriate taxes on it. This absolutely must be considered before making any such withdrawal.
The Medical Expense Exception
The IRS allows you to avoid the 10% early withdrawal penalty under any of a number of specific circumstances, including if you are paying for medical expenses that exceed 7.5% of your adjusted gross income. If your medical expenses do not exceed 7.5% of your adjusted gross income, other exceptions that may apply include exceptions related to disability or unemployment. Specifically, you are allowed to avoid the early withdrawal penalty if you are unemployed and use the withdrawal to pay your health insurance premiums.
Steps to Take Before Making an Early Withdrawal to Pay Your Medical Expenses
In a perfect world, of course, we would all wait until well past 59 ½ to touch the money in our retirement accounts, but realistically, many of us can’t wait right now. If you are considering making an early withdrawal from your 401(k), IRA or other qualified retirement account, here are some first steps to take:
• Review the Summary Plan Description (SPD) for your retirement account. The SPD should give you the specific rules related to making a withdrawal from your retirement account.
• Since your early withdrawal is likely to involve paying taxes on income and possible penalties, assess how much of your medical expenses you can finance from other sources.
• Explore the possibility of borrowing against your retirement account, rather than making a withdrawal from it. If your employer has a 401(k) loan program, a loan is likely to be a much better financial option than an early withdrawal from your 401(k) due to the taxes and potential penalties involved.
If you do make an early withdrawal from your retirement account to pay your medical expenses, be sure to use those funds only for your medical expenses. Keep it squeaky clean in case you get audited!
We want to emphasize again that you should consult with a tax professional before you make any withdrawals from your 401(k), IRA or other retirement plan.
For related information, visit us at MyHealthCafe.com at:
- Tax Season Tip: Paying for Medical Expenses with a 401(k), an IRA or Other Qualified Retirement Plan
- Medicare Open Enrollment: How Much Will It Cost To Pay Your Medical Expenses? Probably More Than You Think
- Tax Season Tips: Last Minute Medical Deduction Tips
- Retirement: It's Not Just About Taxes and the Grandkids
- Tax Season Reminder: Health Insurance Benefits and Domestic Partners