The Internal Revenue Service does not stop you from taking out money from your IRA whenever you want, for whatever reason. However, it does discourage early distributions by imposing early withdrawal penalties. Knowing how these penalties and income taxes will affect your distribution may dissuade you from cashing in early.
When Does the Early-Withdrawal Penalty Apply?
The early-withdrawal penalty only applies when you take a nonqualified distribution from your IRA. For a traditional IRA, your withdrawal is qualified if you are older than 59 1/2. If you are younger, your withdrawal is nonqualified. For a Roth IRA, multiple conditions must be met: The age of your Roth IRA must be at least five tax years and you must either be 59 1/2 years old, permanently disabled or taking out no more than $10,000 for a first home purchase. Failure to meet these conditions results in a nonqualified distribution.
Early Withdrawal Penalty Size
The early-withdrawal penalty equals 10 percent of the taxable portion of your nonqualified IRA distribution. For example, a $3,000 taxable early distribution results in a $300 early withdrawal penalty. Since you deduct your traditional IRA contributions, the entire amount is taxable and therefore subject to the penalty. With a Roth IRA, the IRS requires you remove all your contributions -- tax-free -- before taking out your earnings, which are taxable. Therefore, if you only take out contributions from a Roth IRA, you do not have to pay the early-withdrawal penalty.
Early-Withdrawal Penalty Waivers
In certain circumstances, the IRS allows you to not pay the early-withdrawal penalty on the taxable portion of your IRA distribution. Medical-related waivers include costs of medical expenses exceeding 7.5 percent of your adjusted gross income, medical premiums while you are unemployed or if you become completely disabled. Certain other expenses, such as post-secondary education costs, including room and board if enrolled at least half time, and up to $10,000 to purchase your first home are also exempt. Note that these waivers only apply to the early-withdrawal penalty. You still must pay income taxes.
The IRS does not set a specific income tax rate for your IRA distributions. Instead, the taxable portion of your IRA distribution adds to your taxable income for the year and is taxed like ordinary income. The IRS uses a progressive tax rate, so the higher your other income, the higher your income-tax rate on your IRA distribution. You can find the income-tax rate schedule for your filing status in IRS Publication 17.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."