Money withdrawn from an Individual Retirement Account is typically taxable. One exception to this rule is a Roth IRA. If you withdraw money from any IRA before retirement, you're also likely to face penalties. At the time of your IRA distribution, you can usually specify how much tax you want your financial services firm to withhold. As long as you pay the tax you owe, there is no requirement to withhold at the time of distribution.
Income Taxes on IRA Withdrawals
Whenever you take a distribution from an IRA, you have to report the amount on your taxes. You'll receive a 1099-R from the firm holding your IRA account, showing the amount of your withdrawal. Transfer that figure to line 4a of your Form 1040. If it is taxable, as distributions from a traditional IRA are, enter that amount again on line 4b.
The amount of your withdrawal will filter down to your taxable income as ordinary income. You'll be taxed on that amount at your marginal tax bracket, same as if it were your wages or salary. If your state has an income tax — and most do — you'll also owe state income tax.
Early Withdrawal Penalties
If you take an early withdrawal from your IRA, you won't escape with just taxes. The IRS motivates you to keep your money in your IRA until retirement by charging a 10 percent penalty of any amount you take out before age 59 1/2.
You'll have to complete Form 5329 to compute your early distribution penalty, then transfer it to line 59 of Schedule 4. Coupled with your federal and state income taxes, you could be looking at paying 50 percent or more of your distribution if you are in the highest tax bracket.
Exceptions to the Penalty
In certain cases, you can avoid the additional 10 percent early distribution penalty. If you take out up to $10,000 to buy, build or repair your first home, you are exempt. You can also take penalty-free withdrawals to pay for your health insurance, excessive medical expenses, qualified educational expenses and IRS levies, or if you become disabled. Beneficiaries of inherited IRAs and qualified reservists also avoid the penalty, as do IRA holders taking out regular annual distributions over a lifetime.
Distributions From Roth IRAs
Qualified distributions from a Roth IRA are tax-free. However, one of the requirements of a qualified distribution is that you are over 59 1/2. As a result, premature withdrawals from a Roth IRA may end up being at least partially taxable. IRS rules consider your contributions to be withdrawn first, and those are nontaxable. However, any earnings that you withdraw will be taxable. You'll also be liable for the same 10 percent early distribution penalty attached to all IRAs.