Because a traditional IRA is a tax-favored means of saving for your retirement, a penalty in the form of a 10% additional tax generally applies if you withdraw or use IRA assets before you are age 59 1/2. This is explained under Age 59 1/2 Rule.

However, you generally can make a tax-free withdrawal of contributions if you do it before the due date for filing your tax return for the year in which you made them. This means that, even if you are under age 59 1/2, the 10% additional tax may not apply. These withdrawals are explained under Contributions Returned Before the Due Date.

Age 59 1/2 Rule

Generally, if you are under age 59 1/2 you must pay a 10% additional tax on the distribution of any assets (money or other property) from your traditional IRA. Distributions before you are age 59 1/2 are called early distributions.

The 10% additional tax applies to the part of the distribution that you have to include in gross income. It is in addition to any regular income tax on that amount.

A number of exceptions to this rule are discussed below under Exceptions. Also see Contributions Returned Before the Due Date, later, and Early Distributions under What Acts Result in Penalties, later.

You may have to pay a 25%, rather than 10%, additional tax if you receive distributions from a SIMPLE IRA before you are age 59 1/2. See Additional Tax on Early Distributions in chapter 4.

After age 59 1/2 and before age 70 1/2. After you reach age 59 1/2, you can receive distributions from your traditional IRA without having to pay the 10% additional tax. Even though you can receive distributions after you reach age 59 1/2, distributions are not required until you reach age 70 1/2. See When Must I Withdraw IRA Assets? (Required Distributions), later in this chapter.

Exceptions

There are several exceptions to the age 59 1/2 rule. Even if you receive a distribution before you are age 59 1/2, you may not have to pay the 10% additional tax if you are in one of the following situations.

• You have unreimbursed medical expenses that are more than 7.5% of your adjusted gross income.
• The distributions are not more than the cost of your medical insurance.
• You are disabled.
• You are the beneficiary of a deceased IRA owner.
• You are receiving distributions in the form of an annuity.
• The distributions are not more than your qualified higher education expenses.
• You use the distributions to buy, build, or rebuild a first home.
• The distribution is due to an IRS levy of the qualified plan.

Most of these exceptions are explained below.

Note. Distributions that are timely and properly rolled over, as discussed earlier, are not subject to either regular income tax or the 10% additional tax. Certain withdrawals of excess contributions after the due date of your return are also tax free and therefore not subject to the 10% additional tax. (See Excess Contributions Withdrawn After Due Date of Return under What Acts Result in Penalties, later.) This also applies to transfers incident to divorce, as discussed earlier under Can I Move Retirement Plan Assets.

Unreimbursed medical expenses. Even if you are under age 59 1/2, you do not have to pay the 10% additional tax on distributions that are not more than:

1. The amount you paid for unreimbursed medical expenses during the year of the distribution, minus
2. 7.5% of your adjusted gross income (defined later) for the year of the distribution.

You can only take into account unreimbursed medical expenses that you would be able to include in figuring a deduction for medical expenses on Schedule A, Form 1040. You do not have to itemize your deductions to take advantage of this exception to the 10% additional tax.

Adjusted gross income. This is the amount on Form 1040, line 33 or Form 1040A, line 19.

Medical insurance. Even if you are under age 59 1/2, you may not have to pay the 10% additional tax on distributions from your traditional IRA during the year that are not more than the amount you paid during the year for medical insurance for yourself, your spouse, and your dependents. You will not have to pay the tax on these amounts if all four of the following conditions apply.

1. You lost your job.
2. You received unemployment compensation paid under any federal or state law for 12 consecutive weeks.
3. You receive the distributions during either the year you received the unemployment compensation or the following year.
4. You receive the distributions no later than 60 days after you have been reemployed.

Disabled. If you become disabled before you reach age 59 1/2, any distributions from your traditional IRA because of your disability are not subject to the 10% additional tax.

You are considered disabled if you can furnish proof that you cannot do any substantial gainful activity because of your physical or mental condition. A physician must determine that your condition can be expected to result in death or to be of long, continued, and indefinite duration.

Beneficiary. If you die before reaching age 59 1/2, the assets in your traditional IRA can be distributed to your beneficiary or to your estate without either having to pay the 10% additional tax.

However, if you inherit a traditional IRA from your deceased spouse and elect to treat it as your own (as discussed under What If I Inherit an IRA, earlier), any distribution you later receive before you reach age 59 1/2 may be subject to the 10% additional tax.

Annuity. You can receive distributions from your traditional IRA that are part of a series of substantially equal payments over your life (or your life expectancy), or over the lives (or the joint life expectancies) of you and your beneficiary, without having to pay the 10% additional tax, even if you receive such distributions before you are age 59 1/2. You must use an IRS-approved distribution method and you must take at least one distribution annually for this exception to apply. The "life expectancy method," when used for this purpose, results in the exact amount required to be distributed, not the minimum amount.

There are two other IRS-approved distribution methods that you can use. They are generally referred to as the "amortization method" and the "annuity factor method." These two methods are not discussed in this publication because they are more complex and generally require professional assistance. See IRS Notice 89-25 in Internal Revenue Cumulative Bulletin 1989-1 for more information on these two methods. To obtain a copy of this notice, see Mail in chapter 5. This notice can also be found in many libraries and IRS offices.

The payments under this exception must continue for at least 5 years, or until you reach age 59 1/2, whichever is the longer period. This 5-year rule does not apply if a change from an approved distribution method is made because of the death or disability of the IRA owner.

If the payments under this exception are changed before the end of the above required periods for any reason other than the death or disability of the IRA owner, he or she will be subject to the 10% additional tax.

For example, if you received a lump-sum distribution of the balance in your traditional IRA before the end of the required period for your annuity distributions and you did not receive it because you were disabled, you would be subject to the 10% additional tax. The tax would apply to the lump-sum distribution and all previous distributions made under the exception rule.

Higher education expenses. Even if you are under age 59 1/2, if you paid expenses for higher education during the year, part (or all) of any distribution may not be subject to the 10% additional tax. The part not subject to the tax is generally the amount that is not more than the qualified higher education expenses (defined later) for the year for education furnished at an eligible educational institution (defined later). The education must be for you, your spouse, or the children or grandchildren of you or your spouse.

When determining the amount of the distribution that is not subject to the 10% additional tax, include qualified higher education expenses paid with any of the following funds.

• An individual's earnings.
• A loan.
• A gift.
• An inheritance given to either the student or the individual making the withdrawal.
• Personal savings (including savings from a qualified state tuition program).

Do not include expenses paid with any of the following funds.

• Tax-free distributions from a Coverdell education savings account (formerly called education IRAs).
• Tax-free scholarships, such as a Pell grant.
• Tax-free employer-provided educational assistance.
• Any tax-free payment (other than a gift, bequest, or devise) due to enrollment at an eligible educational institution.

Qualified higher education expenses. Qualified higher education expenses are tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a student at an eligible educational institution. In addition, if the individual is at least a half-time student, room and board are qualified higher education expenses.

Eligible educational institution. This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in the student aid programs administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

First home. Even if you are under age 59 1/2, you do not have to pay the 10% additional tax on distributions you receive to buy, build, or rebuild a first home. To qualify for treatment as a first-time homebuyer distribution, the distribution must meet all the following requirements.

1. It must be used to pay qualified acquisition costs (defined later) before the close of the 120th day after the day you received it.
2. It must be used to pay qualified acquisition costs for the main home of a first-time homebuyer (defined later) who is any of the following.
1. Yourself.
2. Your spouse.
3. Your or your spouse's child.
4. Your or your spouse's grandchild.
5. Your or your spouse's parent or other ancestor.
3. When added to all your prior qualified first-time homebuyer distributions, if any, the total distributions cannot be more than $10,000.

If both you and your spouse are first-time homebuyers (defined later), each of you can receive distributions up to $10,000 for a first home without having to pay the 10% additional tax.

Qualified acquisition costs. Qualified acquisition costs include the following items.

1. Costs of buying, building, or rebuilding a home.
2. Any usual or reasonable settlement, financing, or other closing costs.

First-time homebuyer. Generally, you are a first-time homebuyer if you had no present interest in a main home during the 2-year period ending on the date of acquisition of the home which the distribution is being used to buy, build, or rebuild. If you are married, your spouse must also meet this no-ownership requirement.

Date of acquisition. The date of acquisition is the date that:

1. You enter into a binding contract to buy the main home for which the distribution is being used, or
2. The building or rebuilding of the main home for which the distribution is being used begins.

Contributions Returned Before the Due Date

If you made IRA contributions for 2001, you can withdraw them tax free by the due date of your return. If you have an extension of time to file your return, you can withdraw them tax free by the extended due date. You can do this if, for each contribution you withdraw, both of the following conditions apply.

1. You did not take a deduction for the contribution.
2. You also withdraw any interest or other income earned on the contribution. You can take into account any loss on the contribution while it was in the IRA when calculating the amount that must be withdrawn. If there was a loss, the net income earned on the contribution may be a negative amount.

Note. If the trustee of your IRA is unable to calculate the amount you must withdraw, get IRS Notice 2000-39. The notice explains the IRS-approved method of calculating the amount you must withdraw. To obtain a copy of this notice, see Mail in chapter 5. This notice can also be found in many libraries and IRS offices.

You must include in income any earnings on the contributions you withdraw. Include the earnings in income for the year in which you made the contributions, not the year in which you withdraw them.

Generally, except for any part of a withdrawal that is a return of nondeductible contributions (basis), any withdrawal of your contributions after the due date (or extended due date) of your return will be treated as a taxable distribution. Another exception is the return of an excess contribution as discussed under What Acts Result in Penalties, later.

Early distributions tax. The 10% additional tax on distributions made before you reach age 59 1/2 does not apply to these tax-free withdrawals of your contributions. However, the distribution of interest or other income must be reported on Form 5329 and, unless the distribution qualifies as an exception to the age 59 1/2 rule, it will be subject to this tax. See Early Distributions under What Acts Result in Penalties, later.

Excess contributions tax. If any part of these contributions is an excess contribution for 2000, it is subject to a 6% excise tax. You will not have to pay the 6% tax if any 2000 excess contribution was withdrawn by April 16, 2001 (plus extensions), and if any 2001 excess contribution is withdrawn by April 15, 2002 (plus extensions). See Excess Contributions under What Acts Result in Penalties, later.

You may be able to treat a contribution made to one type of IRA as having been made to a different type of IRA. This is called recharacterizing the contribution. See Recharacterizations in chapter 2 for more information.

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