Your self-directed IRA is (or should be) the backbone of your retirement planning strategy. With its tax benefits and broad investment options, the self-directed IRA is a great tool to help you reach your goals.
But in some circumstances, you may actually want or need to take money out of your self-directed IRA before retirement. In general, doing so will incur not only a tax liability (in the case of a traditional self-directed IRA), but a 10% early withdrawal penalty on the amount of the distribution. This 10% penalty is significant, but perhaps more importantly you also lose the future potential for the growth of the funds you withdraw, because an early distribution is not a loan – you’ll never be allowed to repay or redeposit the funds to your account later.
Therefore, if you find yourself in a situation needing to withdraw funds from your self-directed IRA, it would be best to find a situation where you could do so on a penalty-free basis in order to minimize the overall costs. The most commonly used options for making a penalty free early withdrawal from your self-directed IRA include:
Medical Expenses. If you have medical expenses in any given year that exceed 7.5% of your adjusted gross income, and to the extent that you’re not reimbursed for those expenses from insurance or some other type of coverage, then you can take a penalty free withdrawals from your retirement account to cover the amount in excess of the 7.5% figure.
During a period of long-term unemployment, you can also make penalty free early withdrawals from your self-directed IRA in order to pay the health insurance premiums for yourself and your family.
First Time Home Buyer. You can withdraw up to $10,000 from your account on a penalty free basis in order to pay all or part of a down payment on a new home. For purposes of this penalty free early withdrawal, “new home” means that you have not been a homeowner at any point during the past two years.
You can also use this exception to benefit a child or grandchild is looking to buy their first home. However, it’s important to note that the maximum amount of these withdrawals is limited to a total of $10,000 over the course of your lifetime. This means that you could help one child with a $10,000 early withdrawal, or give two children $5,000 each (but not $10,000 each).
Certain Educational Expenses. You can withdraw funds from your account to pay the “qualified” higher education expenses for yourself or your children or grandchildren. In order to qualify, these expenses must be at an educational institution that’s eligible to receive federal financial aid funds or loan guarantees, and they expenses must be for tuition, room and board, books or other required expenses.
Note that in the case of a Roth self-directed IRA, your account and its deposits must be at least five years old and others make these withdrawals a penalty free basis. While you want to minimize any early withdrawals from your self-directed IRA, choosing a penalty-free distribution if it’s available can lessen the impact.