Individual Retirement Accounts (IRAs) are an attractive savings vehicle in the U.S. For anyone approaching or contemplating early withdrawal from an IRA, understanding its withdrawal mechanics, possible tax ramifications and penalties as well as possible exceptions is paramount to their success. In this article we explore these matters further and will cover both mechanics of withdrawal as well as potential tax implications as well as exceptions that apply.
First and foremost, it’s vitally important to differentiate the different types of IRAs as their withdrawal rules differ slightly:
Traditional IRA: Your contributions may be tax-deductible and earnings will grow tax-free until it comes time for withdrawals, when taxes become due on them.
Roth IRA contributions are made using after-tax dollars, so withdrawals upon retirement may typically be tax-free.
Age Matters: Between 59 1/2 to 60 1/2
Withdrawals Before Age 59 1/2: Early withdrawal penalties typically range between 10%-15%; any funds removed early could also be subject to income taxes and are therefore taxed as income.
Roth IRA contributions may be withdrawn tax and penalty free at any time; earnings withdrawn before age 59 1/2 could incur taxes and penalties.
After Age 59 1/2:
Traditional IRA withdrawals after the age of 59 1/2 will be subject to income tax at your current tax rate without penalty or additional taxable amount being withheld from any withdrawals made before that age.
Qualified Roth IRA withdrawals are free of taxes and penalties; to qualify, at least five years must have passed since making your initial contribution and you are over 59 1/2.
RMDs (Required Minimum Distributions)
If you own a Traditional IRA, by April 1 of the year following the calendar year in which you turn 72 you must begin withdrawing required minimum distributions (RMDs), which are minimum amounts you must withdraw each year from it. Failing to take out this minimum withdrawal or missing the deadline can result in a tax penalty equalling 50% on whatever remains undistributed from your IRA account.
Roth IRAs don’t impose RMDs during an account owner’s lifetime, unlike Traditional IRAs which do.
Exemptions apply to the 10% Early Withdrawal Penalty
There are certain circumstances wherein the IRS allows withdrawal from an IRA without incurring its 10% penalty, such as:
- First Time Home Purchase: Withdraw up to $10,000 of savings towards purchasing or building your first home.
- Higher Education Expenses: Withdrawals can be used for qualified education expenses for yourself, your spouse and any descendants.
- Birth or Adoption: Up to $5,000 may be available without penalty within one year after this event occurs.
- Unreimbursed Medical Expenses: When medical expenses exceed 7.5% of your adjusted gross income.
- Health Insurance Premiums: Have been unemployed for an extended period.
It is always prudent to consult a tax expert when planning to withdraw funds from an IRA, since traditional IRA distributions may be taxed as ordinary income while qualified Roth IRA distributions tend to be free from federal income tax liability.
How to Withdraw
In order to withdraw, contact your financial institution where your IRA is housed to initiate withdrawal proceedings. Depending on where your institution resides, withdrawal requests could either be submitted online, over the phone, or as paper forms.
Being knowledgeable of IRA withdrawals will prevent penalties or tax implications from surprising you, while leaving as much money in your account to grow over time as possible is ideal, life’s unpredictable events may necessitate early withdrawals at times – being informed will enable you to make informed decisions for both your financial health and retirement future.