Understanding IRA Withdrawal Penalties

May 7th 2016

Basic Penalties

The IRS imposes a 10 percent penalty for receiving distributions, or withdrawing, from an IRA before you turn 59 1/2 years old. You pay this penalty on top of any taxes you owe for the original disbursement that you include with your gross income. If your tax bracket comes in at 25 percent, you owe a 35 percent tax on the amount you withdraw from an IRA. Citizens pay taxes on IRA withdrawals rather than the upfront income used to build up the account in the first place, thereby delaying income tax liabilities on that income until later in life. You may have to pay state income tax penalties on top of federal penalties.

Circumstantial Exceptions

Several exceptions may alleviate the burden of paying the extra penalty, but you must pay normal income taxes on IRA distributions. If you use the money to pay for college, purchase your first home or pay for unreimbursed medical expenses, you do not owe the penalty. A taxpayer may also use an IRA withdrawal to cover expenses due to disability of the owner or to pay benefits upon the death of the account holder. The IRS may also take part of an IRA to cover a tax liability or tax deficiency.

Investment Exceptions

If you transfer money from one IRA to another qualified retirement plan, commonly called a rollover, you do not owe the extra 10 percent in taxes. You have 60 days to transfer the money into another account.

Required Minimum Distribution

If you do not start receiving money from an IRA by the year you turn 70, the IRS imposes a 50 percent tax on the money you do not withdraw. From ages 59 1/2 to 70, you can withdraw whatever money you want from an IRA and pay the normal tax rate based on your gross income. Talk to the account administrator to start receiving payments from the IRA.

Tax Reporting

Report distributions from an IRA on Form 1040, and any penalties on Form 5329. When you report expenses with regards to exceptions to penalties, those go on Form 1040 Schedule A for itemized deductions. File these forms at the beginning of each tax year before April 15.

Conclusion

The Internal Revenue Service imposes penalties on taxpayers who withdraw money early from an individual retirement account. The penalties exist to discourage people from using the savings for purposes other than retirement. The agency waives the additional tax if certain circumstances have occurred. Learn what these IRA withdrawal penalties entail and what the exceptions mean with this easy-to-follow guide.

Sources

Traditional and ROTH IRAs represent a tax advantage for retirees who save money in interest-bearing accounts. Talk to your financial adviser about viable options for an IRA in your name.

Learn the penalties and exceptions for early withdrawals from IRAs. "IRS.gov" Topic 557 - Additional tax on early distributions from traditional and ROTH IRAs
http://www.irs.gov/taxtopics/tc557.html "Schwab.com" IRA withdrawal rules

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