The U.S. Congress authorized the creation of individual retirement accounts as a means of allowing individual taxpayers to set aside a portion of their earned income toward retirement in a tax-advantaged account. To discourage early withdrawals from these retirement accounts, Congress imposed a significant tax penalty on funds withdrawn prior to the taxpayer reaching retirement age. While the early distribution tax penalty may be avoided in the event of certain hardships, the income tax obligation on those funds still remains.
Individual retirement account may share a number of features with certain other types of qualified retirement plans, but there is one significant difference. All of the funds in your IRA always belong to you. Since you always own 100 percent of the funds in your account, you have the right to withdraw those funds at any time, for any reason.
Early Withdrawal Tax Consequences
While you have the right to withdraw all or any portion of funds from your IRA at any time, non-qualified withdrawals will usually incur a tax penalty. The Internal Revenue Service considers withdrawals from your IRA prior to the age of 59 1/2 years to be non-qualified. If you have a Roth IRA, any growth that occurred on funds in your account must additionally have remained in your Roth IRA for at least five years before it becomes eligible for qualified withdrawal. The tax penalty for non-qualified withdrawals as of the 2011 tax year was 10 percent of the non-qualified amount withdrawn.
Unlike certain other types of qualified retirement plans, there is no such thing as a hardship withdrawal from your individual retirement account. This is because you own all of the funds in your account and can withdraw them at any time, regardless of the reason. The Internal Revenue Service will waive the additional tax penalty on early withdrawals from your IRA under certain circumstances, which may include certain hardships, such as paying for medical expenses that exceed 7.5 percent of your adjusted gross income or if you become disabled prior to reaching age 59 1/2 years. Although the IRS may waive the 10 percent tax penalty, non-qualified withdrawals will always result in a taxable event. You must report the amount of your non-qualified withdrawals when you file your federal income tax return. It will be taxed as ordinary income in the year you received it. There is no mechanism for deferring taxes on your non-qualified withdrawals, even in the event of a hardship, other than rolling your withdrawal over into another qualified plan.
You can withdraw any amount you contributed to a Roth individual retirement account at any time, for any reason, without incurring any tax consequences, since you have already paid taxes on those funds. The only funds in your Roth IRA that are subject to early withdrawal taxes and penalties are the earnings on your contributions. If you have a hardship that requires you to access funds in your Roth IRA you will not incur a tax liability until your total withdrawals exceed your total contributions.
- Internal Revenue Service: Publication 590, Are Distributions Taxable?
- Internal Revenue Service: Publication 590, Early Distributions
- Internal Revenue Service: Publication 590, Roth IRAs
- Internal Revenue Service: Retirement Plans FAQs regarding Hardship Distributions
- U.S. Department of Labor: FAQs About Pension Plans And ERISA