Your taxes on IRA withdrawals depend on your situation, account type and purpose for making withdrawals; in some instances there may even be no income tax due.
IRAs can offer many advantages, from greater investment options and flexibility to tax savings. But what happens if you withdraw funds before retirement?
Contributions
Contributing to either a traditional IRA or Roth IRA provides you with an upfront tax break; when withdrawing funds from either account however, taxes may apply on withdrawal. The exact amount depends on what type of IRA it is as well as whether an employer retirement plan covers you as well as income and deduction limit restrictions.
Individuals with earned income, such as wages, salaries or tips from employment as well as compensation from self-employment activities, can make contributions to an IRA. There are certain limits set forth by the IRS on how much can be deducted each year depending on filing status and modified adjusted gross income (MAGI).
If your income exceeds these limits, withdrawing from an IRA before age 59 1/2 could incur penalties. Consult a financial advisor on strategies for how to avoid this situation or use SmartAsset’s free advisor matching tool to find professionals near your area.
Earnings
Investment income earned within an IRA will accrue tax-deferred until it’s time to withdraw it, with taxes payable depending on your type of IRA, age and use of funds.
If you withdraw funds from either a traditional or SEP IRA before reaching age 59 1/2, an early withdrawal penalty may also apply. However, you can access your savings without penalty to cover qualified expenses such as higher education expenses, uninsured medical bills that exceed 7.5% of your adjusted gross income and first-time home purchases. Roth IRA withdrawals do not incur taxes, offering an important advantage for those needing access to their retirement funds early. For tax-deferred accounts, to reduce taxable withdrawals you should utilize strategies such as tapping taxable accounts before taking RMDs from tax-deferred ones or using a QLAC. However, to maximize tax efficiency it’s always a good idea to consult a financial adviser so you don’t incur additional taxes and penalties.
Withdrawals
Withdrawals made from your IRA are usually subject to taxes; however, you may be exempt from penalties if you’re under age 59 1/2 and/or have certain expenses such as medical insurance premiums for people out of work for at least 12 weeks, first-time home purchases or higher education expenses that qualify. Your Thrivent Financial advisor can assist in calculating what taxes may be due and filling out necessary forms.
The rules governing an IRA mandate that your custodian withhold 10% of your gross withdrawal for federal income tax, unless you elect otherwise. This amount is sent directly to the IRS as prepayment towards your future tax liability.
If you own a traditional IRA, the Internal Revenue Code stipulates that your initial required minimum distribution be taken by April 1 of the year in which you turn 70 1/2. With the SECURE Act pushing this deadline back until 2023, it’s essential to speak to a tax professional to make sure you meet RMD obligations each year.
Taxes
Money placed in individual retirement accounts (IRAs) should be for retirement, but life may present unexpected obstacles that require early withdrawal of those funds. The IRS has rules regarding early withdrawal penalties of 10% as well as what forms you need to file with them.
If you withdraw funds from a Traditional, SEP or SIMPLE IRA prior to reaching age 59 1/2, they’re typically considered taxable income and subject to a 10% penalty tax unless one of several exceptions apply; Roth IRAs do not fall under this penalty tax category.
Once you reach 70 1/2, if applicable to you, you must report a Required Minimum Distribution (RMD). Your RMD is calculated based on the value of your account at year-end divided by your life expectancy factor as listed in IRS Publication 590-B.
If you choose someone other than your spouse as beneficiary of an IRA, filing Form 8606 is required in order to track their basis in the account and avoid double taxation.
