Early Withdrawals from Your Self-Directed IRA
The IRA was created to give individuals a tax-advantaged option to save for their retirements, and exercise more control over such accounts than workers traditionally had with employer-sponsored pensions. In exchange for such benefits, however, the IRS requires that the accounts truly be for retirement purposes, so an individual who takes funds out of their account will be faced with a 10% penalty on the amount of the withdrawal, on top of whatever taxes might otherwise be due.
But there are a few situation in which the IRS will waive that 10% penalty, and these can potentially provide you with the opportunity to make financially sound early withdrawals from your self-directed IRA.
To Pay Down High-Interest Debt. This isn’t necessarily a good idea for everyone. But if having too much high interest debt is impacting other areas of your personal finances, then it could potentially be worth taking an early withdrawal from your self-directed IRA — although the amount of that withdrawal should be as small as is necessary to accomplish your goals.
For example, if you find that servicing your credit card debt is preventing you from being able to afford adequate health insurance, or that your credit score has dropped to the point where it’s become more expensive to take out car loans or get a new mortgage, then an early withdrawal from your self-directed IRA might make sense.
To Improve Your Career. You may already be aware that you can take penalty-free early distributions from your self-directed IRA to pay for so-called “qualified educational expenses.” These expenses include not only tuition, but also room, board, and other expenses that are a necessary part of attending a qualified educational institution (not just traditional colleges and universities, but also vocational schools and other organizations that are eligible to participate in federally guaranteed financial aid programs).
This exemption is normally pitched as a way to pay an IRA account owner to pay for their child’s educational expenses. Many financial experts would advise that it’s usually better not to sacrifice one’s retirement future to help their child pay for college, and that a better path forward would involve a greater contribution from the child, taking on student loans, and perhaps even considering less expensive educational options.
But you can also use this penalty-free exemption to improve your own education, and to boost your career in the process. Again, you should investigate other financial options (such as low-interest federally guaranteed student loans if you’re eligible) before taking a distribution from your retirement account.
To Buy a Home. If you’re a first-time homebuyer (which simply means that you haven’t owned a home at any point during the last two years), then you can take an early withdrawal of up to $10,000 to help you cover the purchase of that property. This type of early withdrawal can be a great financial choice if it’s the difference between you being able to purchase a suitable home versus continuing to rent.
Any action that reduces the size of your retirement nest egg should be done only with caution, and after considering all your alternatives. But in some circumstances taking an early withdrawal from your self-directed IRA might make good financial sense.