Early Withdrawal Penalties - Traditional and Roth IRAs in header of articles
Early Withdrawal Penalties - Traditional and Roth IRAs
There’s a difference between withdrawing funds from a traditional IRA and withdrawing funds from a Roth IRA. We’ll tell you how each might affect your taxes.
Traditional IRAs The IRS will charge you a 10% early withdrawal penalty if both of these apply:
You withdraw money from your traditional IRA.
You're younger than age 59 1/2.
This is true unless you qualify for an exception
Death -- If the IRA is distributed because the owner dies, there’s no penalty. It doesn't matter how old the IRA owner was at the time of death, or the age of the beneficiary.
Disability -- There’s no penalty if you become permanently disabled. To qualify for the disability exception:
You must be unable to do substantial gainful activity.
Your disability -- either mental or physical -- must be expected to:
Lead to death
Last for a long, continued, and indefinite time
Medical bills -- You might use money to pay unreimbursed medical expenses that are more than 7.50% of your adjusted gross income (AGI). If you do, you won't pay a penalty. If you’re age 65 or older, the threshold is only 7.5% of AGI.
Medical insurance -- You might receive unemployment wages for part of the year and meet certain conditions. If so, you'll pay no penalty on IRA distributions. However, you must use them to pay for medical insurance to cover:
To receive the penalty exemption, you must meet all of these conditions:
You lost your job. If you're self-employed and your business is defunct, you might also qualify for this exception.
You received unemployment pay for at least 12 weeks in a row.
You received the distributions in the year you received the unemployment pay or the following year.
You receive the distributions no later than 60 days after you've gotten a new job.
Payments over life expectancy -- You won't pay a penalty if the IRA distribution is part of a series. They must be substantially equal payments over one of these:
Your life expectancy
You and your beneficiary's joint life expectancies
You must follow the distribution methods approved by the IRS to figure the required payments. To avoid the penalty, these withdrawals must last:
For at least five years
Until you’re at least age 59 1/2
First-home purchase -- You can withdraw up to $10,000 from an IRA without a penalty. You must use this to help you buy, build, or rebuild a first home for:
Your children or grandchildren
Your parents or other ancestor
The lifetime limit is $10,000 . However, you and your spouse can each withdraw $10,000 from your IRAs. Together, you can have a total of $20,000.
You must use the money within 120 days from the date you withdrew it to qualify for the exception. In this case, a first-time homebuyer is someone who hasn’t owned an interest in a main home for at least two years.
Education expenses -- You won’t pay a penalty if you use the money to pay qualified higher-education expenses for:
Your child or grandchild
Qualified expenses for all students include:
Room and board -- Students must be enrolled at least half-time for this expense to qualify.
The expenses must be required for attendance at one of these:
Other postsecondary educational institution
Qualified reservists -- You don't have to pay the additional 10% penalty tax on your distributions if you meet these conditions:
You were ordered or called to active duty after Sept. 11, 2001.
You were ordered or called to active duty for either:
A period of more than 179 days
An indefinite period of time because you were in the reserves in one of these:
U.S. Army National Guard
U.S. Air National Guard
U.S. Army Reserves
U.S. Navy Reserves
U.S. Marine Reserves
U.S. Air Force Reserves
U.S. Coast Guard Reserves
Reserve corps of the public health service
The distribution is from either:
Amounts from elective deferrals under a 401(k) or 403(b) plan
The distribution was made between these dates:
No earlier than the date of the order or call to active duty
No later than the close of the active-duty period
IRS levy -- The IRS might have levied the distribution. If so, you won't have to pay the 10% additional tax.
The amount you can withdraw is unlimited. However, the distribution is still subject to income tax. It could be taxed at a rate as high as 39.6% depending on your tax bracket.
Roth IRAs Unlike traditional IRA withdrawals, qualified Roth IRA payments and distributions are tax-free. However, you must meet certain requirements.
First, you must make the withdrawal five years after the year you made your first contribution. The account doesn't have to be open five full years.
Also, for the payments to be a qualified distribution, they must be one of these:
Made after reaching age 59 1/2
Made to a beneficiary or to your estate after your death
Made after you became disabled
Meet the penalty exception for a first-time homebuyer
When you withdraw your money from a Roth IRA, your contributions and earnings come out in this order:
Conversion contributions -- on a first-in, first-out basis
Earnings on contributions
You've already paid tax on your Roth IRA contributions. So, you can withdraw your regular contributions at any time and at any age with no penalty or tax. After you withdraw an amount equal to all of your regular contributions, the earnings will be taxable. This is only true if the distribution isn't a qualified distribution. If the distribution is qualified, then your distribution won't be taxed.
All of your Roth IRAs are treated as one for withdrawal purposes. It doesn't matter how many Roth IRA accounts you have.
Converted Amounts and Early Withdrawal Penalty You might convert a traditional IRA to a Roth IRA. To take a tax-free distribution the money must stay in the Roth IRA for five years after the year you make the conversion.
If you withdraw contributions before the five-year period, you could have to pay a 10% penalty. This is an early withdrawal penalty on the entire distribution. You usually pay the 10% penalty on the amount you converted. A separate five-year period applies to each conversion.
If you're at least age 59 1/2 when you make the withdrawal, you won't pay the 10% penalty. This applies no matter how long the money is in the account. You also won't pay a penalty if you:
Use the distribution for a first-time home purchase -- up to a $10,000 lifetime limit
Qualify for other exceptions that apply to traditional IRAs
Distribution Ordering Rules for Roth IRAs If the money you withdraw from a Roth IRA isn't a qualified distribution, part of it might be taxable. Your money comes out of a Roth IRA in this order:
Regular contributions -- always tax- and penalty-free
Conversion contributions -- which come out on a first-in, first-out basis. So conversions from the earliest year come out first.
Earnings on contributions
Roth IRA Earnings Your earnings are tax-free if both of these are true:
You've had the Roth IRA for at least five years.
You're age 59 and 1/2 or older when you withdraw the money.
The earnings you withdraw are tax-free at any age if both of these apply:
You've had the Roth IRA for at least five years.
You qualify for one of these exceptions:
You used the money for a first-time home purchase -- up to the $10,000 lifetime limit.
You became totally and permanently disabled.
Your heirs received the money distributed after your death.
If you die before meeting the five-year test, the IRS will tax your beneficiaries on distributed earnings until the five-year test is met.
No matter your age, your earnings are taxable if you don't meet the five-year test. This is true even if your earnings are penalty-free.
Each traditional IRA you convert to a Roth IRA has its own five-year holding period.
The IRS requires your IRA custodian or trustee to send you Form 5498. This shows your:
Annual IRA contributions
Roth IRA conversions
You should receive the form by the end of May. Keep these records even though you don’t report your Roth contributions on your return.
When you withdraw money from your Roth IRA, report it on Form 8606. This form keeps track of your basis in regular Roth contributions and conversions. It lets you see if you've withdrawn earnings. If you've held your Roth IRA for at least five years and you're older than age 59 1/2, all withdrawals are tax-free.
Traditional IRA Distributions If you wait until you're older than age 59 1/2, you won’t pay the 10% penalty. However, you might have deducted your traditional IRA contributions. If so, the money you withdraw is taxable. If you made nondeductible contributions, part of your withdrawal will be tax-free.
Required Minimum Distributions You must begin withdrawing money from your traditional IRA by April 1 the year after you reach age 70 1/2. If you don't withdraw the minimum amount, the IRS will assess a penalty equal to 50% of the amount you should have withdrawn.
If your 70th birthday is between January and June, you'll turn age 70 1/2 before the end of that year. At that time, you must start taking the required minimum distribution from your IRA by April 1 of the next year. However, you might want to take your first distribution in the year you turned age 70 1/2. By doing this, you avoid having to take two distributions in the next calendar year.
If your 70th birthday is after June 30, both of these apply:
Your first required minimum distribution will be for the year after your birthday.
You could wait until April 1 of the year after that to take the distribution.
Minimum withdrawals are based on life expectancy. Find out what your minimum required distribution is. Then, you can take the full amount from just one account or from several accounts.
If you fail to withdraw the minimum required amount, you'll have a 50% penalty. If you have reasonable cause for not withdrawing the minimum amount, the IRS might waive the penalty.
Getting Your Money Early You can receive distributions from your traditional IRA before age 59 1/2 without paying the 10% penalty. To do so, these conditions must apply:
The distributions must be part of a series of substantially equal periodic payments over your life. They could also be over the joint lives of you and your beneficiary.
You must use a distribution method the IRS approves, and you must take at least one distribution annually.
You must continue making these withdrawals for at least five years and until you're at least age 59 1/2.
If by age 59 1/2 you haven't been receiving payment for at least five years, you might have to pay the 10% penalty.
Also, if you change your method of distribution after reaching age 59 1/2, you might still have to pay a penalty. This might apply even if you haven't take distributions for five years. In that case, the tax applies only to payments distributed before you reach age 59 1/2.
This distribution method saves you the 10% penalty. However, you'll still have to pay income tax on any amount not considered a return of your nondeductible contributions.
Roth IRA Distributions If you've held your Roth IRA for at least five years and you're older than age 59 1/2, money you withdraw will be tax-free. If you open a Roth IRA account after you turn 59 1/2, you still have to wait at least five years before you can take tax-free distributions of your earnings. However, you can take tax-free withdrawals of your contributions at any time.
There’s no required minimum distribution for a Roth IRA prior to the account owner’s death. So, you're not required to withdraw any money during your lifetime. This is an advantage over a traditional IRA.
Death and the Traditional IRA If a person dies while there's still money in their traditional IRA account, the beneficiaries:
Won’t pay the 10% penalty -- the deceased’s age or the beneficiaries’ ages don't matter.
Will pay taxes on distributions the deceased took if the deceased would have paid taxes on the distributions. It doesn't matter that the funds are inherited.
If the deceased had a basis in the IRA, the beneficiaries inherit this basis. They must use Form 8606 to figure the taxable portion of the distributions.
If you inherit an IRA from your spouse, you can treat the IRA as your own. Then, you can put off taking the required minimum distribution until you reach age 70 1/2. If you're not a spouse, you must figure your required minimum distributions from the account. To do this, you must use the IRS life expectancy table for beneficiaries.
Death and the Roth IRA Roth IRAs have different guidelines. If you inherit a Roth IRA, you can withdraw the money tax-free. However, the IRA must first meet the five-year period.
If you inherit the Roth from your spouse, you can treat it as your own. You won’t need to make required withdrawals during your lifetime.
However, if you're not the deceased’s spouse, you must either:
Withdraw everything from the Roth IRA within five years of the owner's death
Begin withdrawals by Dec. 31 of the year after the owner's death. The amount you must withdraw is based on your (the beneficiary's) life expectancy.