So many of the questions eRollover gets about IRAs and 401k Plans involve understanding the ramifications of taking the money out after you have made your contribution. Times are definitely tough, however an investor needs to think long and hard before tapping into their IRA. eRollover wants its readers and members to understand the potential downfalls for taking a distribution out of your Roth, SEP, SIMPLE, or Traditional IRA .
But before we get into that, let's make one thing clear: You are putting money into an IRA for retirement. If you expect to need that money between here and there, tuck them into a savings account instead of an IRA. By withdrawing money from an IRA early, you are essentially giving money away because of the penalties you will have to pay. Unless there is an unforeseen emergency that leaves you with no other options, do not withdraw early from your IRA!
When can I withdraw without penalty?
Generally speaking, you cannot withdraw money from a Traditional, SEP or SIMPLE IRA before 59 ½, and you have to start withdrawing at 70 ½ (see exceptions below).
You must take your first payout (called "mandatory distribution") by April 1 of the year after you turn 70 ½, though you can take it the same year as that fabulous 70 ½ birthday. Why mandatory distributions? Because dear old Uncle Sam wants to make sure he gets those taxes that you deferred when you contributed to your IRA. However this year the required minimum distribution at 70 ½ has been suspended due to the market conditions.
The amount you owe for each minimum payment can be found on a chart published by the IRS, which is based on your life expectancy and the amount of money in your IRA. The only exception is if your spouse is your sole IRA beneficiary and he/she is more than 10 years your junior. If that is the case, you will use a different chart to determine your minimum payment.
Roth IRAs are a little different. The government does not force you take a withdrawal at 70 ½ (because it already has your taxes from when you contributed to the IRA!), but you cannot withdraw without penalty unless the account has been open for at least five years and you are at least 59 ½ (see exceptions below).
What happens if I don't take a mandatory distribution?
If you fail to withdraw from a Traditional, SEP or SIMPLE IRA in a given year after you turn 70 ½, you will be required to pay additional taxes on 50% of the amount you were required to withdraw. Not withdrawing to avoid paying taxes doesn't do you any good, and you will end up paying double the taxes on half of the required withdrawal. Do it at the right time and keep more money for yourself!
You are never required to withdraw money from a Roth IRA.
What happens if I withdraw early from my IRA or 401k?
If you withdraw money early from a Traditional, SEP or SIMPLE IRA, as well as a 401k, you owe a penalty tax equal to 10% of the withdrawal plus the ordinary income tax. If you are in a middle to upper tax bracket, it could end up costing you between 35-45%! Do not withdraw from your IRA early unless it is an absolute emergency.
If you withdraw early from a Roth IRA, the amount you withdraw is taxed as if it is regular income. That means that by withdrawing early from a Roth IRA, you pay income tax twice on the amount withdrawn. Nobody wants that!
Are there exceptions to early withdrawal rules for my IRA?
Yes. You can withdraw early and without penalty from your Traditional, Roth, SEP or SIMPLE IRA if …
- … you are buying your first home (up to $10,000).
- … you are paying for qualified education expenses.
- … you are paying for medical expenses not covered by your insurance (up to the difference between those non-covered expenses and 7.5% of your AGI).
- … you have become disabled and have been unemployed for more than 12 weeks.
- … you are the beneficiary of a deceased individual's IRA and you have not rolled over that IRA to your own IRA.
- … the IRS withdraws money because of a levy.
- … you are forced to take out Substantially Equal Periodic Payments for everyday expenses (consult with your financial advisor to address the complex details).
- … you are a qualified military reservist called to active duty (if you are called to military duty, consult with your financial advisor to ensure you qualify for this exception).
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