The rules for individual retirement accounts (IRAs) let you remove money whenever you want. However, before you liquidate and throw a party, consider both the taxes and the early-withdrawal penalties that apply to non-qualified distributions. For traditional IRAs, if you're not 59 1/2, your distribution is non-qualified. For Roth IRAs, your account has to be at least five tax years old and you have to be either 59 1/2, permanently disabled, or using no more than $10,000 to buy your first home. Actually liquidating the account is relatively simple, but the tax reporting is more complicated.
Complete a distribution request form and submit it to your financial institution. You'll have to provide identifying information, such as your Social Security number and account number, and the amount you want to withdraw. At the end of the year, the financial institution will send you a Form 1099-R documenting your distribution.
Figure the taxable and nontaxable portion of your distribution. Since you're liquidating the entire IRA, it won't matter whether you have a traditional or a Roth IRA: The amount of nondeductible contributions to the account won't be taxable but any earnings or deductible contributions will be taxable. For example, say you've made $10,000 in nondeductible contributions to your IRA and it's now worth $14,000, you'll only have to pay taxes on $4,000. However, if you haven't made any nondeductible contributions, as is common with a traditional IRA, you'll pay taxes on the entire distribution.
Report the taxable portion of the IRA distribution on Line 15b of Form 1040. If a portion of distribution is tax-free, report the entire amount of the distribution on line 15a of Form 1040. Say you've liquidated your IRA worth $20,000 and only $6,000 is taxable. On Line 15b, report the $6,000 taxable portion and on Line 15a, report the entire $20,000 liquidation.
Complete Form 5329, Part I, to figure the additional tax penalty of the liquidation. This penalty equals 10 percent of the taxable portion of the liquidation unless an exception, such as paying for higher education expenses or medical costs exceeding a specified percentage of your adjusted gross income. For example, if you don't have an exception and $6,000 of your distribution is taxable, you'll owe a $600 penalty.
Report the penalty, if any, on line 58 of Form 1040. This penalty adds to the amount of tax you owe.
Report any withholding from the liquidation of your IRA, found in Box 4 of Form 1099-R, on line 62 of Form 1040. This withholding offsets your income taxes for the year.
Items you will need
- IRS Form 1099-R
- IRS Form 1040
- IRS Form 5329
- Comstock/Comstock/Getty Images
- Non-Qualified IRA Withdrawal Penalties
- How Much Tax Do I Have to Pay After Liquidating My IRA?
- How Do I Calculate an IRA Penalty?
- How to Cash Out My Roth After Leaving My Job
- Borrowing Against an IRA
- How to Handle 529 Plan Distributions
- How to Calculate IRA Liquidation Taxes
- How to Convert a Self-Directed IRA to a Self-Directed Roth