Money that you can withdraw from an IRA (Individual Retirement Account) is supposed to be there for the retirement years and the purpose of the account is to leave contributions in for an extended amount of time to build up the account. The Internal Revenue Service (IRS) writes rules that govern the penalties and the taxes that can be levied against an individual that withdraws funds from the account before reaching the age of retirement or the age specified in the terms of the account. Let’s look at what determines the age of retirement.
There are a lot of different answers to what the age of retirement is. Social Security benefits generally are available around age 62, but these requirements are changing as our population is aging and the funds are exhausted. The IRS says that funds from a retirement account can be distributed without penalty, and some without taxation, at an earlier age. The IRS sets the age of retirement for removal of funds from retirement accounts at age 59 ½. This is from a traditional account and is considered a regular distribution. If you can withdraw from an IRA that is contributed under the Roth program, however, you must meet an additional qualification. You can only begin withdrawal from the Roth IRA if you have had the fund for a minimum of five years.
The money you withdraw from an IRA can be distributed before you reach the age of 59 ½. These are called early distributions and they do not meet the eligibility rules for regular distribution. The IRS will assess a penalty of ten percent for early withdrawal. Then, when you file your personal income tax return for the tax year in which you withdrew from the fund, you will be required to add that money to your adjusted gross income just like other income from the year. This can place you in a higher income bracket and you may have to pay even higher taxes. You will be taxed on the withdrawal just as you are taxed on your earnings. If the money was an early distribution from a Roth IRA you will not have to report it as income nor pay taxes because the money contributed to the fund was done after paying taxes. If the account earned interest income, then you will have to pay taxes on the amount of the withdrawal that is attributed to interest income and this money will have a ten percent penalty applied.
Each IRA has a tax structure that is followed when monies are deposited and withdrawn from the account. A traditional IRA contribution will reduce the taxable income for the tax year the money is deposited in the fund. This means that taxation of the money is deferred to a date when the money is withdrawn from the account. You will not pay taxes on the interest, capital gains, or not have to add the money as income in the year that the contribution is made. An IRS Form 1099 will be mailed to you at the end of the tax year by the account administrator when you withdraw money from a traditional IRA.
If you contribute to a Roth IRA, then you pay taxes on the money before you deposit it into the fund. If you withdraw from the fund under regular distributions, then you will not receive an IRS Form 1099 for withdrawals made during the tax year. You will not always have penalties associated with early withdrawal but it depends on what the funds are used for. If you are going to school and you have expenses for your education, then the penalty is waived by the IRS. If you are buying a home and you are a first time home buyer, you will also be given an exception to the IRS rules on an early withdrawal. You can use these funds for your spouse, your child, and your grandchild as well. Finally, if you have a hardship created by medical bills, you can also apply for the waiver from the penalty. If you need a hardship waiver you should contact your tax preparer before you can withdraw from an IRA without violating any of the provisions the IRS has for this type of distribution.