A Traditional IRA, Roth IRA, and SIMPLE IRA will trigger a 10% early withdrawal penalty on funds taken out prior to age 59 1/2, although there are some exceptions to this rule of thumb.
TRADITIONAL IRA: Withdrawals of both principal contributions and investment earnings before age 59 1/2 are subject to a 10% early distribution penalty on top of regular income taxes.
ROTH IRA: Because a Roth IRA is funded with after-tax money, one can withdraw contributions at any time, at any age, penalty-free; however, withdrawing before age 59 1/2 OR before meeting the (5) year aging rule subjects it to the 10% early withdrawal penalty and ordinary income taxes.
SIMPLE IRA: Withdrawing funds from a SIMPLE IRA within the first (2) years of participation in the plan, the early withdrawal penalty increases to 25%. After the (2) year period, it drops down to the standard 10% penalty if withdrawn before age 59 1/2.
Most individuals dealing with a Traditional or SIMPLE IRA may face a 10% early withdrawal penalty, with only a handful having a Roth IRA that has not aged at least (5) years.
Since an Individual Retirement Account (IRA) is created through a licensed financial institution, such as a bank, credit union, savings and loan association, or an IRS-approved Nonbank Trustee or Custodian. An IRA is a private contract between two parties that agree to penalties for early withdrawals. Because of this, we believe this 'indirect tax' is unavoidable at this current time, save for the exceptions listed below. Even when penalty-free, it is generally subject to income tax, although this can be avoided with redemption in lawful money.
ALLOWED EXCEPTIONS FOR EARLY WITHDRAWAL PENALTY
Rule of 55: If one leaves their job in the year they turn 55+, one can take penalty-free withdrawals from that employer's 401(k).
Hardship Withdrawal: Withdrawals for immediate and heavy financial needs, such as medical expenses, educational expenses, or to prevent eviction, may be allowed without penalty if approved by one's plan administrator.
Substantially Equal Periodic Payments (SEPP): Taking a series of equal payments based on one's life expectancy, but one must follow IRS rules.
401(k) Loan: One can borrow from their 401(k) without penalty, but it must be repaid with interest within (5) years.
Rolling 401(k) into IRA or Roth IRA: One must wait (5) years before withdrawing these converted funds to avoid a penalty.
Other Exceptions: Penalty-free withdrawals may be permitted for reasons such as qualified birth or adoption expenses, disability or terminal illness, federally declared disasters, domestic abuse, emergency personal expenses, certain medical expenses, military service, Qualified Domestic Relations Orders (QDROs), IRS levies, and first-time home purchases.