An Individual Retirement Account (IRA), as the name suggests, is an account, and not something that can be physically sold. However, it does hold investments that can be sold, and when the account is then closed, the IRA has effectively been sold. There are three primary ways to close an IRA; each involves distinct tax characteristics and consequences, so you should carefully choose the manner in which you dispose of your IRA.
Transfer your IRA. If you establish a separate IRA at another firm, you can transfer over your original IRA and close it without having to sell any of the securities inside, although you can sell the securities and transfer over only cash, if you desire. Additionally, performing such a "trustee-to-trustee" transfer avoids any tax consequences. As long as the transfer is completed within 60 days of its origination, the IRS views this as a tax-free action. This is usually the simplest, safest way to close your original IRA.
Withdraw cash from your IRA. If you want to have your IRA funds now, you can sell all of your securities and withdraw the cash in one lump sum. However, there are tax consequences for such an action: All of the money that you withdraw from a traditional IRA is immediately taxable at regular income tax rates. Even if you sell stocks and withdraw your funds at a gain, you do not get to use the more favorable capital gains tax rates, as all withdrawals from an IRA are considered ordinary income, not capital gains. Additionally, if you withdraw your IRA funds before the age of 59 1/2, you are subject to a 10% penalty tax courtesy of the IRS. Unless you absolutely need your IRA funds now, this is generally not the best option.
Convert to a Roth. A Roth IRA is a tax-advantaged vehicle much like a traditional IRA, with one important difference. Whereas a traditional IRA is a pretax account, a Roth IRA is funded only with after-tax dollars. As any contributions to a Roth IRA must be made with after-tax dollars, any traditional IRA that funds a Roth must be taxed before the funds can be deposited. From a tax perspective, converting to a Roth is the same as taking a distribution from your traditional IRA, so as in the withdrawal scenario in Step 2, you must pay regular income tax on the entire amount of the conversion. However, once the funds are in the Roth, they grow tax-free until they are distributed, at which time the withdrawals are also tax-free. Depending on your current tax situation and future tax situations, along with the number of years until your retirement, this might be an attractive option.
You should consider consulting with a tax adviser if you are choosing between a tax-free IRA rollover or a taxable Roth IRA conversion.
- IRS Publication 590: Trustee-to-Trustee Transfers
- IRS Publication 590: Taxation of IRA Distributions
- IRS Publication 590: Roth IRA Conversions
- Internal Revenue Service. "Traditional and Roth IRAs." Accessed April 20, 2020.
- Internal Revenue Service. "Topic No. 451 Individual Retirement Arrangements (IRAs)." Accessed April 20, 2020.
- Internal Revenue Service. "Income ranges for determining IRA eligibility change for 2021." Accessed November 1, 2020.
- Internal Revenue Service. "IRA FAQs - Contributions." Accessed April 20, 2020.
- Internal Revenue Service. “Publication 590-A (2019), Contributions to Individual Retirement Arrangements (IRAs).” Accessed April 20, 2020.
- Internal Revenue Service. "Rollover Chart." Accessed April 20, 2020.
- Internal Revenue Service. "Rollovers of Retirement Plan and IRA Distributions." Accessed April 20, 2020.
- You should consider consulting with a tax adviser if you are choosing between a tax-free IRA rollover or a taxable Roth IRA conversion.
John Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to writing thousands of articles for various online publications, he has published five educational books for young adults.