If you're like most people, when you make contributions to your IRA, you intend to leave the money alone for decades until you can comfortably retire. If you find yourself in desperate financial straits, however, you can withdraw the money early, but you'll face income taxes and extra tax penalties.
The amount of tax you will have to pay when liquidating your IRA will depend on the type of IRA you have established and your age when distributions begin.
Exploring Taxable Income
When you liquidate your IRA, you'll only owe taxes on the portion of the distribution that comes from deductible contributions and earnings. For a traditional IRA, this generally means the entire distribution. However, if you've made nondeductible contributions to your traditional IRA, those aren't taxed when you withdraw them. Similarly, since all Roth IRA distributions are nondeductible, you get those out tax-free. Suppose you've got $15,000 of contributions in your Roth IRA and a total of $22,000 in the account when you liquidate it. No income tax will be required during the distribution.
Assessing the Tax Rate
There's no set tax rate for IRA liquidations. According to IRS Publication 590B, the taxable part of your IRA distribution gets included in your taxable income for the year — in other words, it's taxed at your regular income tax rate, depending on your tax bracket. For example, if you fall in the 12 percent tax bracket, a $7,000 taxable distribution costs you $840. If you're in the 35 percent tax bracket, that same distribution costs you $2,450 in income taxes.
Early Withdrawal Penalties
You'll also usually owe a 10 percent additional tax penalty if you're under age 59 1/2 when you liquidate. Like the income taxes, the penalty only applies to the taxable portion of your distribution, so if $15,000 of your distribution is tax-free and $7,000 is taxable, you'll owe only a $700 penalty. This penalty is added to whatever income taxes you owe on the distribution.
Exceptions to the Penalty
Sometimes, you can avoid the early withdrawal penalty. The IRS has a list of exceptions that, if you meet the criteria, exempt you from all or a portion of the penalty. For example, if you're permanently disabled, you can withdraw as much as you want penalty-free. Or, if you're going back to school, you can withdraw up to the cost of tuition, fees and, if you're enrolled at least half-time, room and board without being penalized. However, no matter what your exception, you still have to pay the required income taxes.