An IRA, or individual retirement account, is a tax-advantaged savings account that allows you to save money for retirement outside of your employer's retirement plan. The Internal Revenue Service (IRS) establishes the guidelines concerning IRA contributions and withdrawals and the tax implications of each. If you currently have money saved in an IRA and are considering making an early withdrawal, it's important to understand the potential penalties involved.
Definition
According to the IRS, an early withdrawal of IRA funds is one made prior to reaching age 59 1/2. Withdrawals made prior to satisfying the age requirement are typically subject to a ten percent early withdrawal penalty. This penalty may not apply if the funds are withdrawn for the purpose of rolling them over or converting them to another IRA or if they meet the IRS guidelines for an early withdrawal exception.
Exceptions
According to the IRS, you may be able to avoid the early withdrawal penalty for health-related reasons if you have unreimbursed medical expenses that are more than 7.5 percent of your adjusted gross income, the distributions are equal to or less than the cost of your medical insurance or you become disabled. An exception may be made if you are the beneficiary of a deceased IRA owner, you are receiving distributions through an annuity or a qualified reservist distribution or the distribution is due to an IRS levy of your retirement plan. You may also make early withdrawals to build or purchase a first home or for qualified education expenses.
Traditional IRA Early Withdrawals
If your funds are held in a traditional IRA, funds withdrawn early must meet one of the IRS exceptions to avoid the ten percent early withdrawal penalty. The IRS also requires that any distributions from a traditional IRA be claimed as gross income for tax purposes, meaning early distributions of earnings and deductible contributions are also subject to regular income tax. If you're withdrawing funds from a traditional IRA to convert to a Roth IRA, the ten percent early withdrawal penalty will not apply, so long as the funds are redeposited within 60 days. You will, however, have to pay income taxes on the distribution for the current tax year.
Roth IRA Early Withdrawals
According to the IRS, you may only make an early withdrawal from a Roth IRA if the account has been open for a minimum of five years. While non-exempt early withdrawals of earnings are subject to the ten percent early withdrawal penalty, the Roth IRA does offer a significant tax advantage in that any early withdrawals of contributions only may be made penalty-free.
Considerations
Before making an early withdrawal for a non-exempt purpose, you should consider the tax implications of doing so. If you currently have funds held in multiple IRAs, the IRS considers them one for withdrawal purposes. For example, if you have a traditional IRA that is funded with both deductible and nondeductible contributions, the IRS will not distinguish between the two for tax purposes. If you're making an early withdrawal for the purpose of converting to a Roth IRA, this may significantly impact your tax liability.
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