How much you will pay in taxes when you withdraw money from an individual retirement account (IRA) depends on the type of IRA, your age, and even the purpose of the withdrawal. Sometimes the answer is zero—you owe no taxes. In other cases, you owe income tax on the money you withdraw. You can even owe an additional penalty if you withdraw funds before age 59½. On the other hand, after a certain age, you may be required to withdraw some money every year and pay taxes on it.
There are multiple IRA options and many places to open these accounts, but the Roth IRA and the traditional IRA are by far the most widely held types. The withdrawal rules forother types of IRAs are similar to the traditional IRA, with some minor unique differences. These other types include the SEP IRA, SIMPLE IRA, and SARSEP IRA. Each has different rules about who can open one. But before getting into the details, you should know that the Internal Revenue Service (IRS) refers to a withdrawal from an IRA as a distribution.
- Tax-free withdrawals are only available from Roth IRAs. When the money was deposited, the income tax was paid.
- If you remove money before the age of 5912, you must pay income tax and perhaps a 10% penalty, unless you qualify for an exemption or are withdrawing Roth contributions (but not Roth earnings).
- You must take money from every form of IRA except a Roth at the age of 72, whether you need it or not, and pay income taxes on it.
Tax-Free Withdrawals: Roth IRAs Only
When you invest in a Roth IRA, you are depositing funds that have already been taxed. You pay no tax on the money you remove, presumably after retirement, nor on any of the profits your investments achieved. That is a major advantage.
To qualify for this tax-free withdrawal, the funds must have been placed into the IRA and kept for at least five years, and you must be at least 5912 years old.
If you need the money sooner, you may withdraw your payments without penalty. It is your money, and you have already paid taxes on it.
You cannot, however, touch any of the investment profits. Keep a meticulous record of any money removed before to the age of 5912, and instruct the trustee to use solely your contributions if you are taking monies early. If you do not do this, you may be subject to the same early withdrawal penalties as if you took money out of a conventional IRA.
If you take investment gains rather than contributions from a Roth IRA before the age of 5912, you may be subject to a 10% penalty. It is critical to maintain meticulous records.
“A little-known strategy may allow for a no-strings-attached withdrawal of a Roth IRA at age 55 without the 10% penalty for a retired investor who has a 401(k),” explains James B. Twining, founder and CEO of Financial Plan Inc. in Bellingham, Wash. “The Roth IRA is’reverse rolled’ into the 401(k) before being withdrawn under the age 55 exemption.”
Knowing you may withdraw money without penalty may give you the confidence to put more in a Roth than you would otherwise. If you really want to save for retirement, it is best to avoid taking money out too soon so that it may grow tax-free in your account.
Taxes on Traditional IRA Withdrawals
Traditional IRA contributions are taxed differently than Roth contributions. You donate pre-tax earnings. Each dollar you deposit decreases your taxable income for the year by that amount. When you remove the funds, both the original investment and the profits gained are taxed at your marginal tax rate in the year you withdraw the funds.
If you withdraw money before reaching the age of 5912, you will be given a 10% penalty on top of the standard income tax depending on your tax rate. This punishment has various exceptions (see below).
Avoiding the Early Withdrawal Penalty
There are several hardship exclusions to penalty costs if you withdraw money from a conventional IRA or the investment-earnings part of a Roth IRA before reaching the age of 5912. Examples of common exclusions for you or your heirs include:
- Qualified education expenses
- Purchase of a Qualified First-Time Home
- Disability of the IRA owner
- Death of the IRA owner
- A tax imposed by the Internal Revenue Service on the scheme
- Unreimbursed medical expenses
- A military reservist’s summons to duty
IRS exclusions varied somewhat for IRAs and 401(k) plans; they even change slightly for various kinds of IRAs.
You also avoid the tax penalty if you make an IRA contribution and then change your mind before the extended due date of the tax return for that year. You may withdraw the funds without penalty. Of course, that money will be added to your taxable income for the year.
When you roll money from one eligible IRA into another, you risk incurring a tax penalty for early withdrawal. Working with your IRA trustee to arrange a trustee-to-trustee transfer, also known as a direct transfer, is the safest method to achieve this. If you make a mistake when attempting to roll over the funds without the assistance of a trustee, you may find yourself paying taxes.
“Most plans enable you to provide the recipient institution’s name, address, and account number on the rollover form. That way, you never have to touch the money or worry about paying taxes on an unintentional early distribution “Kristi Sullivan, certified financial planner and owner of Sullivan Financial Planning LLC in Denver, Colorado, agrees.
“In terms of IRA rollovers, you can only perform one every year in which you physically withdraw money from an IRA, get the profits, and then deposit the money into another IRA within 60 days. If you do another, it is completely taxable “Morris Armstrong, a registered financial adviser from Armstrong Financial Strategies in Cheshire, Connecticut, agrees.
Roth IRA funds should not be combined with other forms of IRA accounts. If you do, the monies in your Roth IRA will become taxed.
Some states also levy early withdrawal penalties.
When You Owe Income Tax on a Withdrawal
When you reach the age of 592, you may take funds from any form of IRA without incurring a 10% penalty.
If it’s a Roth IRA and you’ve held one for at least five years, you won’t have to pay any income tax on the withdrawal. You will if it is not.
Traditional IRA contributions are regarded differently than Roth contributions.
If you remove from a regular IRA, SEP IRA, Simple IRA, or SARSEP IRA, you will be taxed at your current tax rate. If you are in the 22% tax bracket, your withdrawal will be taxed at that rate.
You won’t have to pay any income taxes if you keep your money in a regular IRA until you hit another important age milestone. A typical IRA payout will be needed after you reach the age of 72. The age was set at 7012 until the December 2019 enactment of the Setting Every Community Up for Retirement Enhancement (SECURE) Act.
The IRS has precise requirements about the amount you must withdraw each year, known as the required minimum distribution (RMD).If you do not withdraw the appropriate amount, you may be charged a 50% tax on the amount that was not dispersed as needed.
Your Roth IRA has no RMD requirements, but if money remains after your death, your beneficiaries may be required to pay taxes. Your beneficiaries may withdraw the monies in a variety of ways, and they should seek counsel from a financial adviser or the Roth trustee.
The Bottom Line
The money you put into an IRA should be money you want to save for retirement, but unforeseen situations sometimes arise. If you are thinking about withdrawing money before retirement, study the regulations about penalties and attempt to avoid paying an additional 10% to the IRS.
If you believe you may need emergency cash before retiring, consider placing part of your money in a Roth IRA so that it can be accessed without penalty if necessary.
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