Penalty for Early Withdrawal of an IRA

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Individual retirement arrangements, or IRAs, come with nice tax breaks to help you build retirement savings. IRA assets aren’t taxed while in the account. Some allow you to deduct contributions. Roth IRAs don’t allow this, but qualified withdrawals are tax free. In return for giving you these tax advantages, the Internal Revenue Service expects you to leave IRA money alone until you retire. Early distributions may carry a tax penalty.

Traditional IRA Withdrawal Rules

You can add money to a traditional IRA each year up to the IRS limit, and contributions are usually tax write-offs. Taxes are due only when you withdraw money. You are supposed to leave funds in the account until you are 59 1/2 years old. If you take any money out of a traditional IRA early, you must pay 10 percent of the withdrawn amount as a penalty unless the distribution meets IRS rules to qualify as an exception. Taxes and penalties are paid for the year the distribution occurs.

Penalty Exceptions

You may withdraw funds early from an IRA without penalty to pay for qualified higher education costs and to purchase or repair a first home. You may also take money out for health insurance premiums while you are unemployed or to cover qualified medical expenses that exceed 10 percent of your adjusted gross income. The threshold is 7.5 percent if you were born before 1949.

If you become disabled or inherit an IRA, you can take the funds out anytime without penalty. Early distributions from a qualified annuity are also penalty free, as are funds taken out as a qualified reservist distribution or to pay an IRS levy.

Roth IRA Withdrawals

Roth IRA distributions must be qualified to receive tax benefits. A Roth has to be 5 calendar years old before withdrawals can be qualified. In addition, you must be 59 1/2 years old or disabled or inherit the IRA for this benefit. You can use up to $10,000 from a Roth to buy or fix a first home. If a Roth distribution is qualified, you pay no taxes. Unqualified distributions are subject to regular income taxes. In addition, the 10 percent penalty tax applies unless the money is used for one of the exceptions recognized by the IRS. Roth qualifying rules apply only to earnings in the account. Contributions aren’t tax deductible, so you can withdraw them at any time with no penalty or tax liability.

Rollovers, Taxes and Penalties

When you move money from one IRA to another, it is normally not a distribution. If you withdraw money as a rollover, rather than authorizing the IRA trustee to transfer the funds directly to another account, 20 percent will be withheld to cover possible taxes. You have to make up the difference out of pocket or it counts as an early distribution subject to income taxes and the 10 percent penalty.

When you move money from a traditional IRA to a Roth, you must pay income taxes on the funds. However, all the funds you remove from the traditional IRA must go into the Roth, so you have to pay the taxes from other assets like savings. If you hold out part of the transferred money for taxes, it is an early distribution and you may owe the penalty tax.

SEP and SIMPLE IRAs

Simplified Employee Pensions and Savings Incentive Match Plans for Employees, or SIMPLE, IRAs are provided by the employer. Generally, they are subject to the same withdrawal rules and penalties as traditional IRAs. One special rule, however, applies only to SIMPLE IRAs. If you make a distribution from a SIMPLE IRA or do a rollover to another type of IRA during the first two years your employer makes contributions, it is an early distribution and the penalty is 25 percent instead of 10 percent.

References

About the Author

Based in Atlanta, Georgia, W D Adkins has been writing professionally since 2008. He writes about business, personal finance and careers. Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in 2009.

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