What Form Do I Use to Report an Early IRA Withdrawal?

What Form Do I Use to Report an Early IRA Withdrawal?

What Form Do I Use to Report an Early IRA Withdrawal?

An individual retirement arrangement is a type of retirement account that lets you defer taxes on your savings and earnings until you withdraw money. If you withdraw money before the retirement age of 59 1/2, you will often owe your usual income tax rate plus an additional 10-percent penalty. Some exceptions apply depending on how you use the money.

Tip

If you need to pay tax on an early IRA withdrawal, file Internal Revenue Service Form 5329 with your taxes. Also, file any copies of Form 1099-R you receive from your financial institutions.

How IRAs Work

A traditional IRA is a type of retirement account that lets you contribute funds while you are working, deferring taxes until you withdraw them, usually after the retirement age of 59 1/2. You can set up IRAs for yourself at a bank, brokerage or other financial institution of your choice, and it can be worth it to shop around for an account or multiple accounts that offer investment opportunities and fees that fit your needs.

You can contribute up to $5,500 per year to your IRA accounts or up to $6,500 per year starting once you turn 50. The money you contribute is deducted from your taxable income for the tax year you contribute it, and you generally can make contributions into the next calendar year until the April tax filing deadline.

When you withdraw money, you pay ordinary income taxes on it. This can save you money by allowing you to defer taxes until retirement when many people find themselves in lower tax brackets than when they were working. If you take an early IRA withdrawal before 59 1/2, you often must pay an IRA withdrawal penalty of 10 percent in addition to your ordinary income tax. In certain cases, you can claim an exemption from this penalty depending on how the money is spent.

Roth IRAs are a special type of IRA that work differently in reference to taxes. You pay taxes on funds you put into the account as usual but generally do not pay tax on the investment earnings you withdraw after retirement age, allowing your money to grow tax-free. SEP IRAs and SIMPLE IRAs are types of employer-sponsored retirement accounts that function similarly to traditional IRAs for tax purposes once funded.

Early IRA Withdrawal Exceptions

You can take an early IRA withdrawal in certain circumstances without owing the 10-percent tax penalty. You generally will still owe income tax on the money you withdraw.

You can withdraw up to $10,000 as a first-time homebuyer to use for expenses relating to your home purchase, such as a down payment. You can also withdraw money without a tax penalty in many situations if you are in the National Guard or military reserves and you are called to active duty. You can withdraw without a tax penalty for certain higher education expenses for yourself and your family.

A penalty also doesn't usually apply if you're using the money to pay for medical expenses in excess of 7.5 percent of your IRS adjusted gross income or if you're unemployed and are using the money to buy health insurance. If you're disabled, you often can also take early withdrawals without penalty in some circumstances.

If the IRS levies your IRA for unpaid taxes, you're not required to pay a tax penalty on the seized funds.

Early IRA Distribution Tax Form

If you receive any distribution from an IRA or most other types of retirement account, you'll likely receive tax form 1099-R from the organization that processed your withdrawal. You'll generally file this form with your taxes. Follow the instructions with your paper or online tax form to see how to do so.

In some cases, the form may indicate that you are exempt from an early IRA withdrawal penalty, but not all types of exceptions are noted on the form. Most of the exemptions relating to how you spend the money aren't included on 1099-R since they're related to what you do with the money once you receive it, which is outside the control of your financial institution.

If you take an early distribution or some other kind of withdrawal that can incur an IRA withdrawal penalty, you'll usually also need to file IRS Form 5329 with your return. This form will enable you to compute the tax penalty if any, that you owe to the IRS. If some of your early withdrawals are subject to exemptions for the penalty, there is a place to note this and note how much is exempt from the penalty. Consult the form's instructions to see which numeric exemption code to use.

Follow the instructions on the form to see where to enter the tax penalties on your Form 1040 tax return to add them to your total tax liability.

Understanding IRA Rollovers

You can often transfer money between retirement accounts without paying a penalty. This is useful if you leave a job and want to convert your retirement account such as a 401(k) or 403(b) into an IRA, which often has more investment opportunities, or you want to consolidate accounts or move them to a new provider.

This process is known as a rollover. Generally, the easiest way to do a tax-free rollover is to coordinate with the financial institutions involved so that the money is sent from one account directly to a new one.

If you take possession of the funds, rather than having them sent directly, you may be subject to a 20-percent withholding tax. This tax can be refunded when you file your return, but in the meantime, you'll need to make up the difference or pay an early withdrawal tax and penalty. You also must deposit the money into the new account within 60 days or pay a tax penalty, unless certain emergency and hardship exceptions apply.

If you want to convert an IRA to a Roth IRA, this is a special case, since you must pay the deferred income tax on the money in the account to do so. It can be advantageous if you wish to avoid paying tax on future investment earnings in the account. Work with your financial institution to do so and pay the correct tax.

Required Minimum Distributions

After you reach age 70 1/2, you are generally required to start taking a minimum amount of money from your IRA accounts each year. If you don't take the mandatory minimum amounts, you can be subject to a tax penalty of up to 50 percent of the funds you didn't withdraw. This is more than you will pay in federal tax on your earnings under any tax bracket.

The IRS provides tables you can use to compute how much you must withdraw each year. If you fail to take required distributions, you are required to use Form 5329 to compute your tax penalty. As with early withdrawals, follow the instructions on the form to figure out how much you owe as a penalty and transfer it to the appropriate place on your Form 1040.

Special rules apply for inherited IRAs. Roth IRAs generally aren't subject to required minimum distributions unless you inherit one, in which case you must either transfer all the money out of the account or take at least minimum distributions over your life.

Items you will need

  • IRS Form 1099-R
  • IRS Form 1040
  • IRS Form 5329

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About the Author

Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.