If you wanted, you could walk down to the bank in which you keep your individual retirement account and ask to cash out the account at any time. To discourage you from doing so, the Internal Revenue Service imposes a penalty on early withdrawals -- in addition to any income taxes you owe on the amount withdrawn. The IRS also penalizes you if you contribute too much during the year.
Excess Contribution Penalties
If you contribute more than you're allowed, the IRS imposes a 6 percent penalty on the extra money. To figure the penalty, subtract your contribution limit from the amount you put in and multiply the result by 6 percent. For example, say your contribution limit is $5,000 and you put in $6,000. Since you contributed $1,000 too much, you owe a penalty of $60. To avoid the penalty, you must withdrawal the excess plus any earnings accumulated on it by your tax deadline, including extensions.
Early Withdrawal Penalties
If you take a qualified distribution, you're in the clear when it comes to penalties. In addition, the early withdrawal penalty doesn't apply to the withdrawal of nondeductible contributions. With a traditional IRA, the entire distribution is taxable unless you've made nondeductible contributions. If you have, you split your withdrawal proportionally between nondeductible contributions and the remainder of the account. For example, if 28 percent of your traditional IRA value consists of nondeductible contributions, 28 percent comes out tax-free.
With a Roth IRA, your contributions always come out first. So, if your distribution doesn't exceed the amount of contributions in your Roth IRA, you won't pay any taxes or penalties. Withdrawals of earnings, however, count as taxable income.
Early Withdrawal Penalty Exceptions
Even if some or all of your early IRA distribution is taxable, you may yet escape the early withdrawal penalty if you qualify for an exception. If you're permanently disabled or taking a qualified reservist distribution, any amount you withdraw is penalty-free. You can also exempt amounts paid for higher education expenses, up to $10,000 for a first-time home purchase, medical expenses that exceed 7.5 percent of your adjusted gross income, and medical premiums while unemployed. Any portion of your withdrawal covered by an exception is exempt from the early withdrawal penalty, but taxes still apply.
Early Withdrawal Penalty Amount
The IRA early withdrawal penalty equals 10 percent of the taxable portion of the withdrawal that isn't covered by an exemption. For example, say you take a $10,000 distribution from a traditional IRA and only $9,000 is taxable. If you have $5,000 of medical expenses exceeding 7.5 percent of your adjusted gross income, only $4,000 is hit with the penalty, so you'll owe a $400 early withdrawal penalty.
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