Individual retirement accounts, or IRAs, are set up by the IRS to help you save money for retirement. Traditional IRAs allow pretax contributions and tax the money when you withdraw it. Roth IRAs allow after-tax contributions and tax-free distributions during retirement. Both IRAs have restrictions on when you can withdraw money without incurring a penalty.
You usually cannot withdraw money from an IRA before age 59 1/2 without incurring a tax penalty. This penalty is in addition to ordinary income tax you pay on the amount you withdraw before age 59 1/2. The penalty applies to Roth IRAs and includes ordinary income tax, though a Roth otherwise is a tax-free account.
The purpose of the penalty is to encourage you to be forward thinking and long-range in your savings goals. The penalty is intended to discourage early withdrawals.
The penalty is 10 percent of the amount you withdraw for traditional IRAs and 10 percent of any gains you experience for Roth IRAs. For example, if you withdraw $1,000 prior to age 59 1/2 from a traditional IRA, the penalty would be $100. If you withdraw $1,000 from a Roth IRA and $400 represents investment gain, the penalty is $40.
There are certain instances when you can withdraw money from your retirement account without paying a penalty. You may withdraw up to $10,000, as of 2010, for a down payment on your first home. You may also qualify for hardship withdrawals without a penalty if you have medical expenses and you can prove a financial hardship that would prevent you from paying these expenses any other way. You can also make systematic withdrawals before age 59 1/2 without a penalty using an exception under IRS rule 72t, which allows for equal and substantial withdrawals that last at least five years or until you reach age 59 1/2.
Account holders usually are discouraged from withdrawing money from an IRA before age 59 1/2. Even with hardship withdrawals and new home purchases, you are diminishing your retirement savings.
- "Practicing Financial Planning for Professionals (Practitioners' Edition), 10th Edition"; Sid Mittra, Anandi P. Sahu, Robert A Crane; 2007
- "Ernst & Young's Personal Financial Planning Guide, 5th Edition"; Martin Nissenbaum, Barbara J. Raasch, Charles L. Ratner; 2004
- IRS Publication 590: IRAs