Does an Early IRA Withdrawal Affect or Count for Income Tax Purposes?

  Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance      Updated October 25, 2018
  Written by: Jane Meggitt

If you withdraw money from your traditional IRA before the age of 59 1/2, you’re not only taxed on the money, but you end up paying a penalty. The money you withdraw is considered part of your gross income for that year, and you’re taxed according to your income bracket. The IRS levies an additional 10 percent penalty on the amount for the early withdrawal. There are opportunities to avoid paying this penalty, however. If you can wait until your 59 1/2 birthday passes to avail yourself of these funds, you avoid the penalty and only owe taxes on the amount you withdraw. That’s true of any IRA withdrawal after that age, as such funds are taxed as ordinary income. The type of IRA from which you make withdrawals also factors into the penalty tax.

Tips

  • If you withdrawal funds from your IRA before you reach age 59 1/2, you will be forced to pay an early distribution penalty. However, this 10 percent penalty on early distributions may be waived if you are experiencing specific life circumstances that qualify as an exemption.

Exceptions to the Early Distribution Tax Penalty

The IRS waives the 10 percent penalty if you withdraw money from an IRA early for individuals who experience certain life events or require the money for specific purposes. These include:

  • Total and permanent disability
  • Qualified higher education expenses for payments made to an eligible institution of higher education for yourself, your spouse, your children or grandchildren.
  • Qualified first-time homebuyers, with a limit of $10,000
  • Unreimbursed medical expenses totaling more than 10 percent of your adjusted gross income
  • IRS levy on the plan
  • Health insurance payments after a layoff. To qualify, you must receive unemployment compensation for your job loss for at least 12 consecutive weeks.

Roth IRA Exceptions

Roth IRAs differ from other types of IRAs, as your contributions are made with money that has already been taxed. Traditional, SEP and other IRAs are funded with pretax contributions. If you qualify, you can deduct these contributions from your federal income taxes in the year in which you make them. Once you start making withdrawals, ordinary income tax rates apply. You must start making withdrawals by the age of 70 1/2. That’s not the case with Roth IRAs. There are no mandatory withdrawals for Roth IRAs, and you aren’t taxed on the money you withdraw. There is no tax penalty for early withdrawal of a Roth IRA if you have held for at least five years.

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Inherited IRAs

If you’re the beneficiary of an inherited traditional IRA and under age 59 1/2, you usually don’t have to pay the 10 percent penalty when you make early withdrawals. That’s true if you inherit an IRA from someone who isn’t your spouse, even if they were under age 59 1/2 when they died. If you inherit an IRA from your spouse, you have choices. You can choose to consider the inherited IRA as your own IRA. If that’s the case, you are subject to the 10 percent penalty if you make early withdrawals. However, you can also opt to consider the IRA as if it were inherited from a third party, which allows you to make early withdrawals without the penalty. Again, you must pay taxes on inherited IRA distributions as ordinary income. When it comes to inherited traditional IRAs, the IRS considers death as part and parcel of paying taxes.

An inherited Roth IRA falls under different rules. There are no taxes on distributions, and the choices for the spouse are similar to those of traditional IRAs, without the tax issue. If you’re the beneficiary of a non-spousal Roth IRA, you must receive all distributions by Dec. 31 of the year marking the fifth anniversary of the Roth IRA owner’s death, or you can take distributions over your lifetime based on the IRS’ Single Life Expectancy table.

About the Author

A graduate of New York University, Jane Meggitt's work has appeared in dozens of publications, including Sapling, Zack's, Financial Advisor, nj.com, LegalZoom and The Nest.

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