Individual retirement accounts (IRAs) offer tax-sheltered growth and other tax benefits for saving for retirement. Since you're in control of the account, you can withdraw money from your plan at any time, even if you're not yet 59 1/2 years old. However, if you do so, you'll be taking a non-qualified distribution, and you'll see more of your distribution go towards taxes and penalties than if you waited until you could take a qualified distribution.
IRA Income Taxes
Since you got a tax break for contributions to a traditional IRA, when you take money out you have to pay income tax on the distributions. With non-qualified distributions from Roth IRAs, you can withdraw the contributions you put in the Roth IRA without paying taxes. However, if you take out more than you put in, the earnings are subject to income tax. For example, if you've contributed $14,000 to your Roth IRA and you take out $15,000, the first $14,000 is tax-free because that counts as a contribution -- but the last $1,000 is earnings, which are taxable.
Applicable Tax Rates
The taxable portion of your IRA distribution counts as ordinary income on your tax return, so the applicable tax rate depends on the size of the distribution and your other income for the year. For example, if you have minimal other income and a small distribution, your IRA distribution will be taxed at a lower rate than if you have lots of other taxable income and you take a large distribution.
Early Withdrawal Penalties
When you're under 59 1/2, a 10-percent additional tax penalty applies to the portion of your IRA distribution that is subject to income taxes. For example, a taxable $10,000 traditional IRA distribution results in an extra $1,000 in taxes owed. However, if you removed $10,000 in contributions from your Roth IRA so none was taxable, you wouldn't owe any penalties. This penalty is in addition to, not instead of, any income tax you owe on the distribution.
Loss of Tax-Sheltered Growth
Your losses from taking money out of your IRA early go beyond taxes and penalties. Once the money is out, you permanently lose the tax-sheltered growth the IRA offers, and you don't get to put in extra later on to make up for the early distribution. Even if you save extra on your own, the earnings are taxed each year, so it won't grow as quickly. For example, if you save $5,000 in your IRA and it grows to $5,500, that extra $500 isn't taxed immediately, so it compounds your returns. If that same amount isn't in an IRA, the $500 is taxed, and you'll have to divert some of the money to taxes each year, reducing your overall returns.
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