How the IRA Early-Distribution Penalty Works

Early IRA Early-Distribution Penalty Works

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You pay an IRA early-withdrawal penalty when you take money out of your IRA before you reach age 59 1/2. The good news is that transferring an IRA from one account to another is not considered a distribution, so you are free to change financial institutions at any time without worrying about paying a penalty. If you think you need money, you're younger than age 59 1/2, and your IRA is the only place you can get the funds, make sure you know how the early-withdrawal penalty works before you decide to cash in part of your IRA.

Key Takeaways

  • Early IRA withdrawals are taxed at normal income rates with a 10% penalty added.
  • You will have to decide whether to settle your tax liability at the time of withdrawal or later.
  • It's best to avoid early withdrawals—it's difficult to replenish those savings once they've been withdrawn.
  • There are significant opportunity costs when taking funds out of IRA investments.

How the IRA Early-Withdrawal Penalty Works

Here's an example to show how the early-withdrawal penalty works. Suppose you are age 54, and you take $10,000 from your traditional IRA. The penalty would be calculated as follows:

  • The $10,000 would be considered income on your tax return.
  • This income would be included along with your other sources of income to determine the total amount of tax owed for the year.
  • The amount of tax owed on the $10,000 would depend on your income tax rate, which is determined by your total income and deductions.
  • In addition to the tax on the $10,000 early withdrawal, a 10% penalty would be assessed on the withdrawal.
  • In this scenario, that would be an additional $1,000 of tax owed, in addition to the increase in your ordinary income taxes due to the additional $10,000 in income.

If you didn't pay enough during the year, you could owe at tax time, and you could also be hit with an additional penalty from the IRS for underpayment of taxes. To avoid that, when you take your IRA distribution, it is best to have taxes withheld right from the distribution. So if you were taking a $10,000 early distribution, and had 30% in taxes withheld, you would receive a check for $7,000, and $3,000 would get sent right to the IRS for taxes.

Ask Your Financial Institution to Withhold Your Taxes

Your financial institution may be able to estimate the amount of taxes you will owe. If you're concerned about tax consequences, ask your financial institution to withhold for federal taxes, plus another 10% for the early-withdrawal penalty.

Avoiding the Early-Withdrawal Penalty

If you are using an early IRA distribution to pay off debts and avoid potential judgments, think again. Retirement accounts may provide some forms of creditor protection. Many of the creditor-protection rules that apply to 401(k)s also apply to IRAs.

It is tough to save enough to replenish an account after an early withdrawal. You should think of your IRA money as your nest egg. Do everything you can to avoid an early withdrawal. If you have to take funds from your IRA, see if you can qualify for an exception to the early-withdrawal penalty

The early-withdrawal penalty above also applies to early withdrawals taken from 401(k) accounts. Once you reach age 59 1/2 (or age 55 in some cases for a 401(k) plan), the penalty will no longer apply to withdrawals. At that point, any withdrawal becomes ordinary taxable income to you.

Opportunity Costs

The penalty and taxes may not seem that steep at first, but remember, that same $11,000 today would be worth $26,000 15 years down the road if your investments earned 6% annually. Ask yourself, is this my best option? Is it worth the steep tax penalty? What other decisions have I made this year that might impact my taxes? In most cases, it's best to leave your IRA alone if at all possible.

Frequently Asked Questions (FAQs)

Are any IRA early withdrawals permitted?

Yes. There is no penalty for early withdrawals from an IRA that are used to pay for up to $10,000 toward a first-time home purchase, qualified higher education expenses, medical expenses, or in the case of disability.

Does a Roth IRA have different early withdrawal rules?

Yes. You may withdraw money from a Roth IRA with no penalty if your account has been open for at least five years.

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The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
  1. IRS. “What if I Withdraw Money From My IRA?

  2. IRS. ”Topic No. 413 Rollovers From Retirement Plans.”

  3. U.S. Department of Labor. “FAQs About Retirement Plans and ERISA,” Page 13.

  4. IRS. “Topic No. 558 Additional Tax on Early Distributions From Retirement Plans Other Than IRA.”

  5. IRS. "Retirement Topics - Exceptions to Tax on Early Distributions."

  6. Charles Schwab. "Roth IRA Withdrawal Rules."

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