Tapping your individual retirement account before retirement -- that is, taking "non-qualified withdrawals" -- may result in Internal Revenue Service penalties. For traditional IRAs, non-qualified withdrawals refer to any money you take out before turning 59 1/2. For Roth IRAs, any distribution that doesn't meet either of two criteria is non-qualified. First, if the account isn't at least five tax years old, the distribution isn't qualified. Second, if you aren't either 59 1/2, permanently disabled or using $10,000 for a first home, the distribution also isn't qualified.
If your non-qualified IRA distribution isn't taxable, you don't have to pay an early withdrawal penalties. For Roth IRA, you can get your contributions out tax-free at any time. For example, if you've got $8,000 of contributions in a Roth IRA worth $40,000, the first $8,000 you take is considered to be the contributions and is therefore tax-free. With traditional IRAs, you won't get anything out tax-free unless you've put in nondeductible contributions. If you have, you get a fraction of your distribution tax-free based on the amount of nondeductible contributions in your account. For example, if you've got $8,000 of nondeductible contributions in a traditional IRA worth $40,000, 20 percent of your distribution is tax-free. You cannot take out the tax-free money first, as you do with a Roth.
Technically, it's an extra tax, not a penalty, but the result is the same: you must pay an extra 10 percent of the taxable part of the non-qualified withdrawal to Uncle Sam. For example, if you took out $13,000 and the entire amount was taxable, you'd have to pay an extra $1,300 on top of the ordinary income taxes you owe on the non-qualified distribution.
Uncle Sam recognizes a few specific instances in which you won't be penalized for your early withdrawal. However, they're limited and unless you meet the requirements, you don't qualify. Examples include suffering a permanent disability or taking distributions from an inherited IRA. You also avoid the penalty on distributions used for higher education costs, medical premiums while uninsured, medical expenses exceeding the threshold percentage of your adjusted gross income, and up to $10,000 to buy your first home.
Whether you're claiming an exception or not, if any part of your non-qualified withdrawal is taxable, you'll use Form 5329 to figure the penalty. If you've got an exception, look up the code in the Form 5329 instructions and enter it on line 2 along with the amount of the exception. For example, suppose you took money out to pay for your grad school tuition: you would enter code "08" next to line 2 and the amount of your expenses on line 2. If your exception equals or exceeds your taxable distribution, you're safe from any penalties -- but you'll still owe income taxes.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."