Medical IRA Rules

Expensive trips to the doctor could help you tap your IRA penalty-free. Images

If you're not yet able to take qualified withdrawals from your individual retirement account, you might still be able to get your money out penalty-free if you have high enough medical costs. You can always get your Roth IRA contributions out tax-free, but if you're dipping into Roth earnings or any traditional IRA funds, you'll need an exception if you don't want to pay income taxes on the withdrawal plus a 10 percent early withdrawal penalty.

Medical Expenses Exception

The medical expenses exception lets you take out IRA money without penalty to pay medical costs that would be deductible as part of the medical and dental expenses deduction. These costs include health insurance premiums, checkups, preventive care, surgeries, other treatment and prescription drugs, but only to the extent that they exceed 7.5 percent of your adjusted gross income, as of the 2012 tax year. This threshold rises to 10 percent in the 2013 tax year for those under 65. For example, if your AGI is $80,000 and you have $7,000 of expenses, your exception is only $1,000.

Unemployed Health Insurance Exception

If you're out of work, you might also qualify to take out money for medical insurance without having to worry about the 7.5 percent threshold. To qualify, you must have lost your job, received unemployment benefits for at least 12 weeks, received the distributions in the year you received the benefits or the following year and taken out the money no more than 60 days after you found a new job. The premiums can pay for insurance for yourself as well as your spouse and any dependents.

Tax Reporting

When you use one of the exceptions, you need to jump through an extra hoop on your tax return. After reporting the IRA distribution as income, you need to file Form 5329 to report your exceptions to the early withdrawal penalty. Next to line 2, write the code for the exception you're using -- either "05" for medical expenses over 7.5 percent of your AGI or "07" for health insurance premiums paid while unemployed. As long as your IRA withdrawal doesn't exceed the amount of the exception, you avoid any penalties.

Health Savings Account Alternative

If you want to save money for medical expenses, consider a heath savings account rather than an IRA. To contribute, you must be covered by a high-deductible health insurance plan, but your contributions are tax-deductible, the money grows tax-free in the account and your qualified withdrawals come out tax-free. It's like the benefits of a traditional IRA and a Roth IRA rolled into one for medical expenses. Withdrawals are considered qualified if you spend the money on eligible medical expenses, such as care, treatment and preventive services.