Liquidating your individual retirement account (IRA) in your 20s or 30s is going to cost you on your taxes. At that age, your liquidation simply won't count as a qualified distribution from a traditional IRA because you're under 59 1/2. For a Roth IRA, you're liquidation is highly unlikely to be a qualified distribution because the account must have been open for at least five years and you must be either 59 1/2, permanently disabled or using up to $10,000 for a first home. If you did qualify with your Roth IRA, such as if you're permanently disabled, the entire distribution is tax-free. For non-qualified distributions, the taxable portion is also subject to a 10 percent early withdrawal portion.
Subtract any nondeductible contributions from the total value of the IRA to find the taxable portion of the distribution. When you're liquidating the entire account, the ordering rules don't matter because all of the money is distributed. For example, if you're liquidating a $30,000 IRA with $5,000 of nondeductible contributions, $25,000 of the distribution is taxable.
Multiply the taxable portion of your distribution by your marginal tax rate to figure the income taxes on your distribution. Continuing the example, if you fall squarely within the 25 percent tax bracket, multiply $25,000 by 0.25 to find you'll owe $6,250 in income taxes.
Subtract the value of an exceptions from the early withdrawal penalty, if any, from the taxable portion of the distribution to figure the portion subject to the early withdrawal penalty. Exceptions include higher education costs, medical insurance while unemployed and up to $10,000 for a first home. In this example, if you pay $5,000 in qualifying higher education costs, you'll only owe the early withdrawal penalty on $20,000 of the earnings.
Multiply the portion of your distribution hit with the early withdrawal penalty by 10 percent to calculate the tax penalty. Finishing the example, multiply $20,000 by 0.1 to find you'll owe $2,000 in tax penalties on top of the $6,250 in income taxes.
- When figuring your nondeductible contributions, include all contributions if you're liquidating a Roth IRA because Roth IRA contributions are never deductible. If you're liquidating a traditional IRA,
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."