If you withdraw money early from an individual retirement account, the one thing you do not need to worry about is the capital gains tax. You do need to know what kind of IRA you have, how much you have contributed, how much your contributions have gained and if you qualify for a penalty-free withdrawal. All early withdrawals owe a 10-percent penalty unless withdrawn under specific circumstances. What you owe the Internal Revenue Service for the withdrawal depends on your circumstance and the type of IRA you have, but the IRS will treat all capital gains as income and tax them as income.
Determine if you qualify for a penalty-free withdrawal. If you are older than 59-1/2, the withdrawal is not an early withdrawal and cannot be penalized. If you are withdrawing money to pay for your first house, higher education of yourself or an immediate relative, costs of a disability or medical bills over 7.5 percent of your income, you will not be penalized 10 percent.
Determine if you have a traditional IRA or a Roth IRA. If you deduct your contributions from your taxable income, you have a traditional IRA. If you do not, you have a Roth IRA.The company that manages your IRA can provide this information if you are unsure.
Determine the amount you need to withdraw. If you have a traditional IRA, the total amount is considered taxable income, including all capital gains. You must pay income tax at your current income tax rate on the withdrawal.
Calculate how much money you have contributed to Roth IRAs if withdrawing from a Roth. If the withdrawal amount is less than the total value of all contributions you have made, you do not have to pay any tax. You still have to pay the 10-percent penalty if the reason for withdrawal does not fall into one of the categories outlined in Step 1, however.
Calculate how much your contributions have earned if your withdrawal is more than your total contributions into a Roth. You can do this by simply deducting the value of all contributions from the total value of your Roth IRAs. For example, if you have contributed $10,000, the total value in the Roth is $12,000 and you need to withdraw $11,000 for a new car, the first $10,000 is tax-free. You must pay income tax on the final $1,000 of the withdrawal, plus the 10-percent penalty. If you are in the 25 percent tax bracket, you owe the IRS $350 out of the $11,000 withdrawal.
Even though additional earnings may be mostly capital gains, the IRS treats all gains inside an IRA as income and will tax any amount above your total contributions at your income tax rate.
- Charles Schwab: Withdrawal Rules for Traditional IRAs
- Fairmark; Taxable Distributions from Roth IRAs; Kaye Thomas; January 2008
- Bankrate; IRS Rules for Early IRA Withdrawals; Kay Bell; March 2008
- IRS.gov. "Income ranges for determining IRA eligibility change for 2021." Accessed Oct. 30, 2020.
- Internal Revenue Service. "Publication 590-B (2018), Distributions from Individual Retirement Arrangements (IRAs)." Accessed Sept. 30, 2019.
- U.S. Congress. "H.R.1994 - Setting Every Community Up for Retirement Enhancement Act of 2019." Section 113.
- Even though additional earnings may be mostly capital gains, the IRS treats all gains inside an IRA as income and will tax any amount above your total contributions at your income tax rate.
Calla Hummel is a doctoral student studying contraband in international political economy. She supplements her student stipend by writing about personal finance and working as a consultant, as well as hoping that her investments will pan out.