Whether you've already done the deed or are just contemplating an early withdrawal from your traditional individual retirement account, knowing the tax consequences helps you plan ahead for filing your tax return. Money you take out of a traditional IRA before turning 59 1/2 is considered an early distribution.
Like a qualified distribution, you're responsible for paying income taxes on the entire distribution unless you had made nondeductible contributions to the traditional IRA. If you made nondeductible contributions, you divvy up your early withdrawal based on the percentage of nondeductible contributions in your account compared to the total account value.
For example, if you have $7,000 in nondeductible contributions in your $50,000 traditional IRA at the time of the early distribution, 14 percent of your distribution is tax-free. The taxable income counts as ordinary income, so it gets taxed at whatever tax bracket you fall into.
Early Withdrawal Penalties
To deter you from frivolously raiding your traditional IRA before retirement, the Internal Revenue Service charges a 10 percent penalty on the taxable portion of early distributions. For example, if you take a $14,500 early distribution that is fully taxable, you'll owe an extra $1,450 tax penalty. Unless an exception applies, you'll have to pay the penalty on top of the ordinary income taxes.
Sometimes Uncle Sam is willing to cut you some slack, but only if you fit one or more of the exceptions to the early withdrawal penalty. You won't have to pay any penalties no matter how much you withdraw if you're permanently disabled, or if you take a qualified reservist distribution. Other exemptions apply to only a limited amount, such as for higher education costs, or for medical insurance premiums while unemployed.
Taking an early withdrawal from your traditional IRA makes tax filing more involved. First, your financial institution will mail you a Form 1099-R that documents your early withdrawal. You have to use the longer Form 1040. If you have nondeductible contributions in your traditional IRA, fill out Form 8606 to figure the taxable and nontaxable portions. Lastly, you've got to file Form 5329 to either figure your penalty or note your exception, or both.
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."