Early Withdrawals from Individual Retirement Accounts

You may withdraw money from an IRA at any time. However, the withdrawal will trigger income tax liability of the amount withdrawn (except for some Roth IRAs) and a 10 percent penalty tax unless there is an exception to this general rule. Funds in an IRA should be the last nest egg you touch unless the 10 percent penalty can be avoided.

10 percent penalty. Withdrawals from traditional IRAs and Roth IRAs are taxed differently since the 10 percent penalty only applies to the portion of the distribution subject to income tax (except for amounts attributable to Roth conversions within five years):

For a traditional IRA, distributions are treated as coming ratably from contributions and earnings. Only the portion of a distribution attributable to nondeductible contributions is not taxed, while the portion of the distribution attributable to deductible contributions is treated the same as earnings.

For a Roth IRA, distributions are first deemed to be paid out of contributions, which are nondeductible (or already taxed in the case of a rollover situation). Therefore, substantial withdrawals may be made for any reason from Roth IRAs without tax or penalty.

Exceptions. Several exceptions to the 10 percent early-distribution penalty have been created in recent years. Most of these exceptions apply to both traditional IRAs and to Roth IRAs. A distribution is generally considered “early” if made before reaching age 59½. The IRS has identified the following exceptions to the 10 percent penalty for early distributions that are:

     i) Made to a beneficiary or estate on account of the IRA owner's death

     ii) Made on account of disability

     iii) Made as part of a series of substantially equal periodic payments for your life (or life        expectancy) or the joint lives (or joint life expectancies) of you and your designated beneficiary

     iv) Qualified first-time homebuyer distributions

     v) Not in excess of your qualified higher education expenses

     vi) Not in excess of certain medical insurance premiums paid while unemployed

     vii) Not in excess of your unreimbursed medical expenses that are more than a certain percentage of your adjusted gross income

     viii) Due to an IRS levy, or

     ix) A qualified reservist distribution

The general rule of thumb on IRA withdrawals is that a taxpayer should contribute in the first place only those funds that he or she will not touch under any circumstances. However, if emergencies arise, at least it will be up to you, rather than Uncle Sam, to make the decision on the trade off between keeping funds for retirement and using them for certain other important lifetime events.

If you have any further questions on IRA withdrawals, please do not hesitate to reach out to us at info@compliancetax.us