The Medical Expense Exception for Early Withdrawal

Retirement savings vehicles such as 401(k) plans operate under particular tax restrictions and codes. As most people who have such a plan are aware, there are penalties associated with removing funds early—while you have some power to tap into your retirement savings, the IRS enacts a 10% penalty for doing so on top of your regular income tax bill if you are under the age of 59½.

However, there is an exception allowed on this penalty if the funds are being used towards medical expense. Taxpayers are given a 10% adjusted gross income (AGI) threshold on the medical deduction (increased last year from 7.5%). Medical expenses not covered by insurance exceeding that threshold may be paid for with funds from retirement savings without triggering the 10% tax penalty. Note, that the funds are taxable as ordinary income. The documentation of the withdrawal and its uses must be comprehensive. Keep track of when the money was withdrawn, how much of it was used for medical expenses, and be able to show that this money was not reimbursed by an insurer. If the IRS challenges your claim to the exception, you will be compelled to prove before a judge that you met the requirements.

As a general rule, avoid tapping into your retirement savings—the point is to have the money be there after your working life finishes. The tax penalties take a larger bite out of that savings; however, medical needs are often unplanned and serious, and if your savings can help you out of a dire situation, it’s useful to have it there as a failsafe.

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