IRA Hardship Withdrawal: Everything You Need to Know

If you are facing financial hard times, your retirement funds begin to look like a good source of much-needed cash. In cases of dire emergency, you may indeed be able to make withdrawals from those funds before you reach retirement age. However, the potential short-term and long-term consequences can be severe. Nonetheless, if you must make an early withdrawal from an Individual Retirement Account (IRA) or 401(k), there are certain circumstances under which you can minimize the bite from Uncle Sam.

The Covid-19 pandemic and the 2020 CARES Act have made easier for taxpayers to withdraw funds from their retirement accounts. Learn more about taking a CARES Act retirement withdrawal HERE.

What are the Three Types of Retirement Funds?

There are three primary types of tax optimized retirement funds in the United States:

  • Traditional IRAs
  • Roth IRAs
  • 401(k)s

Traditional IRAs

Traditional IRAs are drawn from pre-tax earnings. When you deposit funds in a traditional IRA, the taxes on those funds and your earnings is deferred until after you retire, presumably when your income is lower and you qualify for a lower tax bracket.

Roth IRAs

By contrast, Roth IRAs are drawn from post-tax earnings. Because you pay taxes on Roth IRA deposits up front, you do not have to pay taxes on either the principle or the earnings, provided that your Roth IRA has been open for five years or longer and you are at least 59 ½ years old when you begin making withdrawals.


401(k) funds are sponsored by your employer. You can invest either pre-tax earnings or post-tax earnings, with tax implications similar to those for a traditional or a Roth IRA. Many employers match their employees’ contributions dollar for dollar. The catch is that you can’t access your employer’s contributions to your 401 (k) until you are fully vested in the company, which translates to being employed or a certain length of time which varies but five years is common.

For What Reasons can you Withdrawal from IRA without Penalty?

If you are younger than age 59½, taking withdrawals from either a traditional or Roth IRA or from a 401(k) will usually trigger a 10 percent tax penalty in addition to paying any income taxes that are due. However, there are exceptions that vary depending on whether you are withdrawing from a traditional or a Roth IRA or from a 401 (k). You can avoid tax penalties from withdrawing from a traditional IRA even if you are younger than age 59 ½ for the following reasons

  • Purchasing a first home.
  • Educational expenses for yourself or a family member.
  • Death or disability of a family member.
  • Covering unreimbursed medical expenses.
  • Purchasing health insurance coverage (only if you are not already covered).

To claim one of these exceptions, you will need to complete IRS Form 5329 along with your income tax returns the following year. Even if you avoid the penalty, you will still need to pay taxes on the money you withdraw. This means that you should withdraw enough to cover your needs, plus a little extra for taxes.

Is there a Penalty for Withdrawing from a Roth IRA?

Yes, penalty-free early withdrawals for Roth IRAs apply to only two circumstances: first –time home purchase or death or disability of a family member. However, the penalty for early withdrawal from a Roth IRA only applies to earnings, since you have already paid taxes on the principle. You will also need to submit Form 5329 along with your tax return.

Can you pull money out of a 401k early?

It is possible to make early withdrawals from a 401(k). However, the IRS is especially harsh on early withdrawals from 401 (k) funds. You may make what are known as hardship withdrawals before age 59 ½ for the following reasons:

  • Purchase a first home.
  • Pay for college for yourself or a dependent.
  • Prevent foreclosure or eviction from your home.
  • Cover unreimbursed medical expenses for yourself or a dependent.

However, hardship withdrawals from a 401 (k) differ from hardship withdrawals from an IRA. You will be assessed a 10 percent penalty in addition to paying income taxes on your withdrawal. To avoid the 10 percent penalty on early withdrawals from a 401(k), you must fulfill one of the following circumstances.

  • Total disability.
  • Medical expenses that total more than 7.5 percent of your adjusted gross income (AGI).
  • Court order to give the money to a divorced spouse, child or other dependent.
  • Permanent separation from your job (including voluntary termination) during or after the year you turn 55.
  • Permanent separation at any age with a plan for equal yearly distributions of your 401(k) (once you begin taking distributions, you must continue them until you reach age 59 ½ or for five years, whichever is longer).

How do you avoid Penalty on 401k Withdrawal?

A better option than a hardship withdrawal from your 401(k) may be to take a loan against the value of your 401(k) with an outside lender. The lender places a lien against your 401(k) which remains in place until you repay the loan. Your funds remain in your 401(k), safe from the reach of Uncle Sam. However, if you default on the loan, the lender will have the right to seize your 401(k) to collect payment.

Is it bad to withdraw from IRA?

It should be clear that IRA and 401k withdrawal should be considered a last resort. Even if you avoid tax penalties, you are depleting the available funds available for your retirement so in this sense, it is a bad idea and if can avoid it, you should. If you must borrow, borrow enough to cover your obligations plus taxes, and repay the funds as quickly as possible. After all, you are actually repaying yourself – and your future.

Need to speak with a licensed tax professional? Optima Tax Relief provides a comprehensive range of tax relief services. Schedule a consultation with one of our professionals today.

Can Retirement Contributions Impact your Tax Bill?

Optima Tax Relief provides assistance to individuals struggling with unmanageable IRS tax burdens. To assess your tax situation and determine if you qualify for tax relief, contact us for a free consultation.

tax form with calculator, money and pen

In these economic times, it is vital that employees contribute to their retirement plan in order to ensure that they have additional funds available to them once they decide to officially retire from the workforce. It is also important for taxpayers to understand the tax implications that come with having a retirement plan and what you should know moving forward to avoid owing a tax balance at the end of the tax year. 

What is my contribution limit? In most cases, taxpayers are able to deduct up to $6,000 for a traditional IRA. If you are 50 years or older, you are able to deduct $7,000. If you have a different retirement account, the amount will differ based on your age and type of plan you have chosen. Your contribution amount may also be limited based on the amount of income you earn.

Will I have to pay taxes on any employer contributions that are made to my retirement plan? Typically, taxpayers will not have to include qualified employer contributions to their traditional retirement plan unless they withdraw the money.

Can contributing to an IRA change my tax bracket? Contributing to your retirement plan can change the tax bracket you are typically in, if your income is near a bracket level. It is important to know that contributing to your plan does not have as big of an effect on your income bracket as you may think because each level of your income is taxed at the income tax rate for that bracket. 

How much should I contribute to my retirement plan? This answer for this question will vary per individual. Many tax professionals recommend that you save 10-20 percent of your income throughout your working life. Some things to also keep in mind when determining how much you should contribute are:

  • How close are you to retirement? 
  • How much disposable income do you have left after your expenses?
  • What is your current income?

When can I make retirement plan contributions? This will depend on the type of retirement plan you have. If you have an IRA, you can contribute up to the original due date of your tax return.  You can also make contributions to your 401(k) plan or 403(b) plan until December 31 of the tax year.

If you need tax help, contact us for a free consultation.

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Are Social Security Benefits Taxable?

Under the laws that are presently in place, you may begin to collect Social Security as early as age 62. But if you begin collecting benefits early, your monthly benefit amount will be less than what you would collect if you wait until your full retirement age, which may fall anywhere from age 65 to age 67.

If you have additional income, you may be liable for federal income taxes on your Social Security payments. And if you owe back taxes, Uncle Sam may take a bite out of your benefits as well.

Is Social Security Your Only Income?

If Social Security payments represent your sole source of income, in all likelihood you won’t have to pay federal income taxes on your benefits, unless you are married and file federal income tax returns separately from your spouse. This is because the IRS has established what it calls a base income for Social Security benefits that is exempt from taxes. As a result, unless you earned a very high income while you were working (and are therefore entitled to very large Social Security benefits), the amount that you receive from Social Security alone will probably fall below the tax-exempt base amount. 

Calculating Your Combined Income

To determine your base income, you must perform some simple calculations. First, add half of your total annual Social Security benefits to any other income you received for the previous year. Include tax exempt income and any other income normally excluded from taxation.Compare the total to the base amount (listed below) for the tax filing status that applies to you. If the total is larger than the base amount, you may be subject to federal income taxes for at least part of your Social Security benefits.

Your Base Income

The amount of Social Security benefits that the IRS exempts from taxation depends on your marital status and your total annual gross income. For 2014, the base amounts of tax-free income for Social Security recipients are listed below:

  • Married Filing Jointly:$32,000
  • Single, Head of Household, Qualifying Widow(er) with a dependent child or Married Filing Separately (not living with spouses at any time during the previous year):$25,000
  • Married Filing Separately (living with spouses anytime during the previous year): $0

How Much of Your Social Security Benefits are Taxable?

Even if your income is more than the base amount set by the IRS for your filing status, you won’t have to pay taxes on all of your earnings. Instead, the IRS has established a formula to determine what percentage of your benefits is taxable, based on your income and tax filing status. The formula for 2014 federal income tax returns is described below:

Single, Head of Household or Qualifying Widower:

  • Income between $25,000 and $34,000: up to 50 percent of benefits are taxable
  • Income more than $34,000: up to 85 percent of your benefits may be taxable

Married Filing Jointly:

  • Income between $32,000 and $44,000: up to 50 percent of benefits are taxable
  • Income more than $44,000: up to 85 percent of benefits are taxable

Married Filing Separately: Up to 85 percent of benefits are taxable

Do You Owe Back Taxes?

The Federal Payment Levy Program (FPLP) allows the IRS to seize up to 15 percent of your Social Security benefits to satisfy a tax levy. Lump sum death benefits, Supplemental Security Income (SSI) benefits and benefits paid to children are also exempt from seizure under the FPLP. In addition, taxpayers with incomes that fall below poverty levels set by the Department of Health and Human Services may also be exempt from seizure of their Social Security benefits.

How to Reduce Your Potential Tax Bite

If your circumstances indicate that you will probably be subject to federal income taxes on at least part of your Social Security benefits, do not despair. Even if you are married and file your federal income tax returns separately from your spouse, you will not have to pay 100 percent of your Social Security benefits back to the federal government. Instead, you will be obliged to include all of your Social Security benefits along with any reported income from part-time earnings or investments. 

But the income that you report from your Social Security benefits is entitled to deductions and tax credits just like any other income. Therefore, your final federal income tax obligation may be minimal. Regardless of your circumstances, it is worthwhile to investigate any and all legitimate tax breaks, either on your own or with the assistance of a tax professional.

Tax Free Retirement Plan Gifting Opportunity to Soon Expire

If you want to donate to a worthy cause this year and have retirement money available to do so, you might be able to make the experience even more satisfying by legally dodging taxes

Thanks to the American Taxpayer Relief Act of 2012, individuals over 70 ½ years old can donate up to $100,000 from their retirement plan (a traditional or Roth IRA)  now until December 31st without paying the taxes you would normally have to pay with such a transaction.

Give and avoid taxes

“This gifting opportunity provides a tax-free way to give money to a near and dear cause,” says Gregg R. Wind, CPA, a partner in Wind & Stern LLP. “Taxpayers who are 70 ½ or older can give away as much as $100,000 from their IRA to an eligible charity, without having to include any of the transfer in their gross taxable income,” he says. 

This means that you won’t pay any taxes, your tax bracket will not be affected, you don’t have to itemize the deduction on your tax return and additional tax will not be incurred on your Social Security income. (Conversely, it also means that you can’t write the deduction off on your income taxes.)

Substantial tax savings

The tax savings you can enjoy by taking advantage of this incentive can be considerable, says Wind. “Tax rates go up to 39.6 percent, depending on a variety of factors, and then there are other taxes to consider, such as state taxes, which can often push the tax percentage to 50 percent. This means that your $100,000 donation could turn into about $50,000, whereas taking advantage of this tax relief opportunity would mean gifting the entire $100,000 to the charity.”

Considering that retirees over the age of 70 ½ must begin taking minimum distributions each year, this incentive can be particularly beneficial on a number of levels, says Wind. “If you don’t need the minimum distribution, this gives you a chance to donate the money where it’s needed, as the amount you give counts toward your minimum required distribution.”


The donation must be made directly from the IRA to the charitable organization, says Wind. “You can’t cash out your IRA and write a check. And it must be from an IRA, not a 401K. If you want to donate money from a 401K, you can roll it over into an IRA and then the donation must be made directly from the IRA.”

Eligible organizations for receiving your nontaxable IRA funds are those with a 501(c)(3) designation, which includes many charities, nonprofits, religious organizations and most private and public colleges and universities.

“Many people are loyal to their Alma mater and are glad to donate as a way of thanking the school for helping them be successful, so schools are a popular choice for donations,” says Wind, who suggests checking on the organization you are considering donating to on, which lists recognized registered charities and provides pertinent information.

Act now

This tax incentive has been around since the Pension Protection Act of 2006, but has expired a few times, including at the end of 2011. At that time, it was extended to the end of this year as part of the fiscal cliff agreement. Currently, there is no sign of the incentive being resurrected, so it’s important to act fast. 

“This is an expiring provision at the end of this year, so if you want the satisfaction of helping a worthy cause and saving on taxes, you’ll have to move quickly before the opportunity is gone,” advises Wind. “The window to help support charities on a tax-free basis will be closing soon.”

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Taxes and the Defense of Marriage Act (DOMA)

Edith Windsor, the plaintiff in this ground-breaking case, has recently shaken up the U.S. tax code by overturning the Defense of Marriage Act (DOMA).

State-recognized same-sex marriages are now legally recognized by the federal government with the Supreme Court of the United States’ June 26 ruling invalidating parts of the Defense of Marriage Act (DOMA). Same sex couples that marry in states that recognize same-sex marriages will be able to take advantage of the same tax benefits available to opposite-sex married couples. Lawyers, certified public accountants (CPAs), other professionals and married same-sex couples should know what the changes in taxes and the Defense of Marriage Act mean for them.

Tax-Free Gifts For All

According to TIME, same-sex couples will be able to gift their significant other property tax-free. Before this ruling and according to federal tax law, same-sex couples were subject to taxes beyond the annual $14,000 exemption. For example, if a car, house, portfolio of stocks or any other property was valued at $50,000, the receiving party in the same sex relationship would have to pay taxes on $36,000 ($50,000 – $14,000 (gift exemption)). Now, this ruling states that in states that recognize same-sex marriages, a married same-sex couple can gift each other unlimited gifts tax-free on the federal level.

Beneficial Retirement Tax Benefits

Same-sex couples will now enjoy the same retirement tax-advantage benefits as opposite-sex couples. Before DOMA, only opposite-sex married couples with retirement investment vehicles including 401(k)s and Individual Retirement Accounts (IRAs) could defer disbursements until the age of 70 ½. If a partner of a same-sex couple passed away, the other partner was forced to take a distribution. If the deceased partner was younger than 70 ½, the surviving partner would incur early distribution penalties, in addition to the regular taxes. However, this ruling permits partners in legally recognized same-sex marriages to receive retirement assets without having to take a forced distribution.

Tax-Free Health Benefits

Partners of employees who received health benefits from their employer had to pay taxes on their individual health benefits. This ruling, however, should eliminate that tax obligation because spouses in opposite-sex couples, under federal law, are not taxed.

Married Filing Jointly

The Supreme Court’s decision may also help same-sex couples take more income home in the future and when amending and filing taxes. Individuals filing individually, with the new ruling, can save as much as $6,100 come tax time. Same-sex couples, according to the Internal Revenue Service, whose unions are legally recognized in 13 states, are also able to file jointly. This would permit a same-sex couple to save as much as $12,200 annually. It gives same-sex couples more than 1,000 federal benefits.

Social Security Changes

According to USA Today same-sex couples are now able to receive their partner’s Social Security benefits. With the new DOMA ruling, the surviving partner of a same-sex couple may be able to receive their deceased partner’s Social Security benefits. Prior to this, the surviving spouse of a same-sex couple was deprived of up to $28,968.

This ruling has given same-sex couples many, if not all of the same tax benefits that opposite-sex married couples have enjoyed for decades. Since everyone’s circumstances are different, it is best to speak with legal and financial advisers to determine what your circumstances entitle you to.

Take Credit for Your Retirement

Saving for your retirement can make you eligible for a tax credit worth up to $2,000. If you contribute to an employer-sponsored retirement plan, such as a 401(k) or to an IRA, you may be eligible for the Saver’s Credit.

Here are seven points the IRS would like you to know about the Saver’s Credit:

1. The Saver’s Credit is formally known as the Retirement Savings Contribution Credit. The credit can be worth up to $2,000 for married couples filing a joint return or $1,000 for single taxpayers.

2. Your filing status and the amount of your income affect whether you are eligible for the credit. You may be eligible for the credit on your 2012 tax return if your filing status and income are:

  • Single, married filing separately or qualifying widow or widower, with income up to $28,750
  • Head of Household with income up to $43,125
  • Married Filing Jointly, with income up to $57,500

3. You must be at least 18 years of age to be eligible. You also cannot have been a full-time student in 2012 nor claimed as a dependent on someone else’s tax return.

4. You must contribute to a qualified retirement plan by the due date of your tax return in order to claim the credit. The due date for most people is April 15.

5. The Saver’s Credit reduces the tax you owe.

6. Use IRS Form 8880, Credit for Qualified Retirement Savings Contributions, to claim the credit. Be sure to attach the form to your federal tax return. If you use IRS e-file the software will do this for you.

7. Depending on your income, you may be eligible for other tax benefits if you contribute to a retirement plan. For example, you may be able to deduct all or part of your contributions to a traditional IRA.

For more information on the Saver’s Credit, see IRS Publication 590, Individual Retirement Arrangements. Also see Publication 4703, Retirement Savings Contributions Credit, and Form 8880. They are available at or by calling 800-TAX-FORM (800-829-3676).
Additional IRS Resources:

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