Sometimes people have to reach into their IRAs before age 59 1/2, even when it means paying income tax and penalties on the amount they withdraw. Knowing how these taxes and penalties apply to your situation can help you figure out how much you really need. The rules are different according to whether you are removing money from a traditional or a Roth IRA; the rules also depend on the reason for your early withdrawal.
Distribution Taxable Portion
Generally, if like most people you've always made tax-deductible contributions to your traditional IRA, the entire early withdrawal is taxable. If you've made nondeductible contributions, however -- meaning that you've already paid income tax on a portion of the contributions -- you must pay tax only on the portion on which you have not already paid income tax. For example, if 20 percent of your traditional IRA comes from nondeductible contributions, only 80 percent of your early withdrawal is taxable.
With a Roth IRA, the situation is different. You've already paid tax on all your contributions, and therefore you may remove the entire value of your contributions without paying tax again. For example, if you contributed $5,000 to a Roth IRA that is now worth $6,000, you may take up to $5,000 early and not pay tax or penalties. If you withdraw more than $5,000 -- that is, if you withdraw part of the earnings, that amount counts as taxable income.
The IRS doesn't have a fixed income tax rate applicable to early IRA distributions. When you take an early IRA distribution, the taxable portion of the distribution gets added to your other taxable income. For example, if the IRA distribution puts you in the 15 percent tax bracket, you'll pay 15 percent in income taxes. If you're in a higher income tax bracket, you'll pay a higher rate.
Additional Tax Penalties
The taxable portion of your distributions is subject to the 10 percent additional tax on early distributions, also called the early withdrawal penalty. For example, if your early distribution consists only of nontaxable contributions from a Roth IRA, you won't owe any taxes or penalties. However, if you take a distribution from a traditional IRA and the entire amount is taxable, you'll pay an additional 10 percent tax on that amount.
You can avoid the 10 percent penalty if you qualify for an exemption. No generic "hardship" exception exists, but you can qualify if you suffer a permanent disability or have to pay for medical expenses exceeding a certain percentage of your adjusted gross income. You also don't have to pay the penalty if you use the proceeds to pay for certain higher education expenses, to pay for health insurance premiums while unemployed or if you use up to $10,000 to buy or build your first home. However, you can't avoid any income tax you might owe on these withdrawals.
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