Tax on an IRA withdrawal depends on its type and age; generally early withdrawals from an IRA before age 59 1/2 may incur income tax and an early withdrawal penalty of 10%; exceptions may exist in some circumstances.
Learn the rules and benefits of IRA withdrawals so you can make educated financial decisions for retirement.
Taxes
When making withdrawals from an IRA account, the exact cost depends on both its type and age. Traditional IRA accounts allow you to contribute pretax income and any earnings are tax-deferred until distributions occur.
Roth IRAs, SIMPLE IRAs (used by small business owners), and SARSEP IRAs are all ways you can save for retirement with specific contribution limits and rules in mind.
Typically, to withdraw funds without penalty from an IRA at age 59 1/2. There are a few exceptions, including using the funds for purchasing your first home or paying medical expenses in excess of 7.5% of adjusted gross income. Furthermore, qualified reservists can make penalty-free withdrawals during active service.
Withdrawals
Tax treatment of traditional and Roth IRA withdrawals differs significantly between accounts, as contributions made with pre-tax dollars will have their income taxes deferred until funds are withdrawn from an IRA before age 59 1/2 are subject to an ordinary income tax rate and 10% penalty tax rate.
However, there are a few exceptions. You may take penalty-free distributions from your IRA in certain situations such as paying for birth or adoption costs, unreimbursed medical expenses exceeding 7.5% of adjusted gross income, and federally declared disaster relief relief.
Your IRA provides penalty-free withdrawals that you can use to purchase your first home, pay qualified higher education expenses for yourself or any family members and make emergency withdrawals of up to $1,000 or 50% of vested account balance (whichever is less).
Required minimum distributions (RMDs)
At age 73 (for those born between 1951 and 1960) or 75 (if born post 1960), the IRS requires you to withdraw funds from tax-deferred accounts such as traditional, rollover, SIMPLE and SEP IRAs, most 401(k), 403(b), self-employed 401(k) plans or profit sharing plans, with any withdrawal taxed at your ordinary income rate and any missed or short RMD incurring a 25% penalty fee.
Your RMDs are calculated by dividing the prior December 31 balance in each account by a life expectancy factor published by the IRS in Publication 590-B: Distributions from Individual Retirement Arrangements. As this calculation may be complex, a financial professional or tax advisor should help you calculate how much to withdraw each year. Alternatively, making qualified charitable distributions instead may help mitigate any increases in marginal tax rate as well as potentially increasing Social Security benefits or Medicare premium taxes.
Excess contributions
If you withdraw an amount from your IRA before reaching age 59 1/2, the withdrawal will incur income tax and a 10% penalty unless one of several exceptions apply; these could include buying your first home, medical expenses exceeding 7.5% of adjusted gross income and unemployment compensation payments.
If your excess contribution is large, it could take several years for it to be fully absorbed using the relatively modest annual limit for absorption. Meanwhile, any investment returns generated from excess contributions must pay an excise tax.
Avoid paying this penalty by withdrawing excess contributions and investments earnings before the tax filing deadline (plus extensions) for that year and applying them toward future years’ contribution limits.
