Terminating your IRA may seem like a financial necessity when you experience a significant strain on your budget. Though you can very easily terminate the IRA, the tax filing is more challenging and the tax consequences can be significant, especially if you take a nonqualified distribution. Traditional IRAs require you to be at least 59 1/2 years old to avoid the early withdrawal penalty. Roth IRAs require the same age, but also require your account to be at least five tax years old. Knowing the tax reporting and penalties you will incur may dissuade you from terminating your IRA, but if not, you will at least avoid additional problems with the Internal Revenue Service (IRS).
Withdraw the balance of your IRA account by requesting your financial institution pay the balance to you. The financial institution cannot stop you from terminating your IRA. Your bank will mail you a Form 1099-R at the conclusion of the year to document your distribution.
Complete Form 8606 to calculate the taxable portion of your distribution if you terminated a Roth IRA before age 59 1/2 or the account was five tax years old, or if you terminated a traditional IRA to which you had made nondeductible contributions, which refer to money deposited in the account that you did not claim an income tax deduction. Terminating a Roth IRA that is at least five tax years old when you are at least 59 1/2 years old causes the distribution to be tax-free. Terminating a traditional IRA without nondeductible contributions results in the entire deduction being taxable.
Complete Form 5329 if you are not taking a qualified distribution and any part of your distribution is taxable. The early withdrawal penalty only applies to the taxable portion of your distribution. On this form, you can document you exemption from part or all of the early withdrawal penalty.
File your taxes with Form 1040, reporting the taxable portion of your IRA termination on line 15b and the nontaxable portion on line 15a. Report your early withdrawal penalty, if any, on line 58. If your financial institution held back any of your IRA termination for federal income taxes, include that amount on line 61. When you submit your taxes, include Form 8606 and Form 5329.
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."