Tax Consequences of Taking an Early Distribution from an IRA

Taking Early Retirement Distributions

Individual Retirement Account (IRA) savings are intended to be for retirement only. If there comes a time prior to retirement when you need to withdrawal money out of your IRA it can be costly. If you take an early withdrawal, or early distribution as some people call it, before you reach age 59 1/2, you’ll be required to pay income tax on the amount and in some cases, penalties too.

Tax Consequences Before Age 59 1/2

Generally, if you withdraw money from your IRA before age 59 1/2 and you’re not rolling the money over to another IRA, you can expect to pay a 10% penalty on the amount. You’ll also have to pay income tax, since the amount you withdraw counts as taxable income. If you’re just taking a withdrawal to roll over the amount to a new IRA, you won't be required to pay the penalty and taxes, as long as you complete the rollover in 60 days.

Note that the IRS requires you to report any early distributions when filing your taxes. There are, however, a few situations where money may be withdrawn early without incurring the 10% penalty. These are a few of those:

  • Funds used to pay a qualified tuition or education expense.
  • Medical expenses for which you didn’t receive reimbursement.
  • Should you experience unemployment, you can withdraw from your IRA to purchase medical coverage for you and your family.
  • Certain military service personnel can take penalty-free withdrawals when they’re on active duty.
  • Should you leave your job after you turn 55 years old, you may not be subject to the penalty.
  • Other situations where you don’t have to pay the penalty include disability, death, and setting up an annuity.

There are limits regarding how much you can withdraw for many of these scenarios where you’re exempt from paying the penalty.

Tax Consequences After Age 59 1/2

Once you reach age 59 1/2, you no longer have to worry about paying the 10% penalty should you start to take a distribution from your IRA. You will still have to pay income tax (assuming this was a tax-differed retirement account) on the amount you withdraw.

Once you turn age 70 1/2, though, you’re required to take distributions from your account. Taxpayers nearing age 70 1/2 should also keep in mind that failure to make the required withdrawals could result in a penalty of up to 50%.

 

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