Rules Governing Withdrawals From IRA Accounts

Used properly, IRAs can save you money on your taxes.
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The federal government created individual retirement accounts with the goal of encouraging taxpayers to save for retirement. Though you can get your money out any time, the Internal Revenue Service discourages early withdrawals with extra taxes and penalties. In addition, the rules vary depending on whether you have a traditional or a Roth IRA.

Qualified Withdrawals

Traditional and Roth IRAs have different definitions of "qualified withdrawals." For traditional IRAs, it's simple: if you're 59 1/2 years old when you take the distribution, it's qualified. If you're younger, it's not. Roth IRAs, on the other hand, require you to satisfy two criteria -- failing to satisfy either one results in a non-qualified distribution. The Roth IRA has to be at least 5-tax-years old and you have to be either 59 1/2, suffering from a permanent disability or using no more than $10,000 to buy your first home.

Qualified Withdrawal Tax Treatment

Qualified withdrawals from traditional IRA gets included in your taxable income just like other ordinary income. No special tax rates apply and no penalties are added. The only exception is when you've made nondeductible contributions, in which case the portion of your distribution that comes from the nondeductible contributions comes out tax-free. Roth IRA qualified withdrawals come out totally tax-free. This include all the earnings that accumulated over the years in the account -- but don't forget -- you didn't get a deduction when you contributed.

Non-Qualified Withdrawals

The taxable portion of non-qualified withdrawals, also called early withdrawals, from both traditional and Roth IRAs gets hit with an additional 10 percent tax penalty. However, how the taxable portion is figured varies. With traditional IRAs, the full distribution is taxable unless you've made nondeductible contributions. If you have, the percentage of the distribution equal to the nondeductible contributions in the IRA is tax-free, and therefore penalty-free. With Roth IRA non-qualified withdrawals, you first take out all your contributions tax-free. If you remove all your contributions, then you start taking out the earnings from the Roth IRA, which count as taxable income.

Penalty Exceptions

Even if you have an early withdrawal that's taxable, you might not have to pay the extra 10 percent tax penalty if you qualify for an exception because Uncle Sam's decided that some reasons are good enough. For example, distributions spent on health insurance while unemployed or higher education expenses avoid the penalty. Your entire distribution avoids the penalty if you're permanently disabled or you inherited the IRA account.

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