A client is 55 years old and has contributed to a traditional IRA for many years. They are considering an early withdrawal to cover a significant medical expense. What is the tax implication of this withdrawal?
- AOnly the earnings portion of the withdrawal will be subject to tax and penalty.
- BThe withdrawal will be subject to ordinary income tax but no penalty.
- CThe withdrawal will be tax-free and penalty-free.
- DThe withdrawal will be subject to ordinary income tax and a 10% early withdrawal penalty.
Show answer & explanationAnswer & explanation
Correct answer: B. The withdrawal will be subject to ordinary income tax but no penalty.
Withdrawals from a traditional IRA before age 59½ are generally subject to ordinary income tax and a 10% early withdrawal penalty. However, there is an exception to the 10% penalty for withdrawals used to pay unreimbursed medical expenses exceeding 7.5% of adjusted gross income, but the withdrawal is still subject to ordinary income tax.
Why the other options are wrong
- A. For a Traditional IRA, the entire withdrawal is generally considered pre-tax money and thus fully taxable unless non-deductible contributions were made, which isn't specified here.
- C. Traditional IRA withdrawals are generally taxable, and while there's a penalty exception, they are not tax-free.
- D. This would be true if the withdrawal didn't meet a penalty exception; however, significant medical expenses are a recognized exception to the 10% penalty.
Traditional IRA Early Withdrawal for Medical Expenses
Withdrawals from a Traditional IRA before age 59½ for unreimbursed medical expenses exceeding 7.5% (or 10% in some years) of adjusted gross income are exempt from the 10% early withdrawal penalty, but the withdrawn amount remains subject to ordinary income tax.
- Before age 59½.
- Exempt from 10% early withdrawal penalty.
- Still subject to ordinary income tax.
- Medical expenses must exceed a percentage of AGI.
Memory trick: Early IRA: Taxed, and usually PENALTY, but MED bills get a PASS.