If you get into a financial bind, you might consider taking money out of your individual retirement account. But that can prove to be a costly mistake. In addition to depleting your retirement nest egg, you could face substantial taxes and penalties. Depending on your tax bracket and the state you live in, you could end up paying out more than half of your withdrawal.
Federal Tax Brackets
If you're married and filing jointly, your federal tax rate could be as low as 10 percent, if your taxable income is $17,400 or lower. As your income rises, so does your tax rate. For joint filers, incomes are taxed at 15 percent above $17,400, 25 percent above $70,700, 28 percent above $142,700, and 33 percent above $217,450. The highest tax bracket of 35 percent is reserved for joint filers with taxable incomes above $388,350. Since traditional IRA distributions are considered ordinary income, they are subject to federal tax. Only Roth IRA distributions are typically free from federal tax, although early distributions may still trigger a penalty.
State Income Tax
If your state has an income tax -- and most do -- anything that is taxable income on your federal return will also cost you on your state return, including an early distribution from a traditional IRA. Rates can vary dramatically from state to state and typically rise along with your income, just as with federal tax brackets. As of 2012, the highest tax bracket was in Hawaii, at 11 percent. Nine states -- Washington, Nevada, New Hampshire, Alaska, Tennessee, Texas, South Dakota, Florida and Wyoming -- do not have state income tax.
Early Distribution Penalty
The Internal Revenue Service discourages IRA withdrawals before age 59 1/2, or "retirement age." The penalty for early distributions is 10 percent, on top of any taxes. There are limited exceptions to the penalty, such as withdrawals for higher education expenses, first-time home purchases and some medical costs.
Total Cost
In terms of the cost of your early IRA withdrawal, the worst case scenario is if you are in the highest federal tax bracket, live in a high-tax state and have no exceptions to the early distribution penalty. In that case, your total cost could run as high as 56 percent, using 2012 rates. If you're in the lowest federal bracket, have no state income tax and qualify for a penalty exception, the cost could be as low as 10 percent of your withdrawal. Most middle-class taxpayers can expect to pay from about 30 to 40 percent for an early IRA distribution.
References
- IRS: Publication 590 -- Are Distributions Taxable?
- IRS: Publication 590 -- Early Distributions
- Rutgers: 2012 Marginal Tax Bracket
- IRS: Publication 590 -- Roth IRAs -- Are Distributions Taxable?
- The Tax Foundation: State Individual Income Tax Rates, As of July 1, 2012
- IRS: States Without a State Income Tax
Writer Bio
After receiving a Bachelor of Arts in English from UCLA, John Csiszar earned a Certified Financial Planner designation and served 18 years as an investment adviser. Csiszar has served as a technical writer for various financial firms and has extensive experience writing for online publications.