How much you will pay in taxes when you withdraw money from an individual retirement account (IRA) depends on the type of IRA, your age, and even the purpose of the withdrawal. Sometimes the answer is zero—you owe no taxes. In other cases, you owe income tax on the money you withdraw. You can even owe an additional penalty if you withdraw funds before age 59½. On the other hand, after a certain age, you may be required to withdraw some money every year and pay taxes on it.
The withdrawal rules for other types of IRAs are similar to the traditional IRA, with some minor unique differences. These include the SEP IRA, Simple IRA, and SARSEP IRA. Each has different rules about who can open one.
Before getting into the details, you should know that the Internal Revenue Service (IRS) refers to a withdrawal from an IRA as a “distribution.”
- Only Roth IRAs offer tax-free withdrawals. The income tax was paid when the money was deposited.
- If you withdraw money before age 59½, you will have to pay income tax and even a 10% penalty unless you qualify for an exception or are withdrawing Roth contributions (but not Roth earnings).
- At age 72, you are required to withdraw money from every type of IRA but a Roth—whether you need it or not—and pay income taxes on it.
Tax-Free Withdrawals: Roth IRAs Only
When you invest in a Roth IRA, you deposit your money after it has already been taxed. When you withdraw the money, presumably after retiring, you pay no tax on the money you withdraw or on any of the gains your investments earned. That’s a significant benefit.
To take advantage of this tax-free withdrawal, the money must have been deposited in the IRA and held for at least five years and you must be at least 59½ years old.
If you need the money before that time, you can take out your contributions with no tax penalty. It’s your money and you already paid the tax on it.
However, you can’t touch any of the investment gains. Keep a careful log of any money withdrawn prior to age 59½ and tell the trustee to tap into only your contributions if you’re withdrawing funds early. If you do not do this, you could be charged the same early withdrawal penalties charged for taking money out of a traditional IRA.
If you accidentally withdraw investment earnings rather than just your contributions from a Roth IRA before you are 59½, you can also owe a 10% penalty. It is crucial to keep careful records.
“For a retired investor who has a 401(k), a little-known technique can allow for a no-strings-attached withdrawal of a Roth IRA at age 55 without the 10% penalty,” says James B. Twining, founder and CEO of Financial Plan Inc. in Bellingham, Wash. “The Roth IRA is ‘reverse rolled’ into the 401(k) and then withdrawn under the age 55 exception.”
Knowing you can withdraw money penalty-free might give you the confidence to invest more in a Roth than you’d otherwise feel comfortable doing. If you really want to have enough for retirement, it is, of course, better to avoid withdrawing money early so that it can continue to grow in your account tax-free.
Taxes on Traditional IRA Withdrawals
Money deposited in a traditional IRA is taxed differently from money in a Roth. You contribute pretax income. Each dollar you deposit reduces your taxable income by that amount in that year. When you withdraw the money, both the initial investment and the gains it earned are taxed at your income tax rate in the year you withdraw it.
However, if you withdraw money before you reach age 59½, you will be assessed a 10% penalty in addition to the regular income tax based on your tax bracket. There are some exceptions to this penalty (see below).
Avoiding the Early Withdrawal Penalty
There are some hardship exceptions to penalty charges for withdrawing money from a traditional IRA or the investment-earnings portion of a Roth IRA before you reach age 59½. Common exceptions for you or your heirs include:
- Qualified education expenses
- Qualified first-time home purchase
- Disability of the IRA owner
- Death of the IRA owner
- An Internal Revenue Service levy on the plan
- Unreimbursed medical expenses
- A call to duty of a military reservist
(Note that the IRS exceptions are a little different for IRAs and 401(k) plans, and even vary a little for different types of IRAs.)
You also escape the tax penalty if you make an IRA deposit and change your mind by the extended due date of that year’s tax return. You can withdraw the money without owing the penalty. Of course, that cash will then be added to the year’s taxable income.
The other time you risk a tax penalty for early withdrawal is when you roll over the money from one IRA into another qualified IRA. The safest way to accomplish this is to work with your IRA trustee to arrange a trustee-to-trustee transfer, also called a direct transfer. If you make a mistake trying to roll over the money without the help of a trustee, you could end up owing taxes.
“Most plans allow you to put the name, address, and account number of the receiving institution on their rollover forms. That way, you never have to touch the money or run the risk of paying taxes on an accidental early distribution,” says Kristi Sullivan, certified financial planner of Sullivan Financial Planning LLC in Denver, Colo.
“In terms of IRA rollovers, you can only do one per year where you physically remove money from an IRA, receive the proceeds, and then within 60 days place the money into another IRA. If you do a second, it is fully taxable,” says Morris Armstrong, a registered investment advisor with Armstrong Financial Strategies in Cheshire, Conn.
You should not mix Roth IRA funds with the other types of IRAs. If you do, the Roth IRA funds will become taxable.
Some states also levy early withdrawal penalties.
When You Owe Income Tax on a Withdrawal
Once you reach age 59½, you can withdraw money without a 10% penalty from any type of IRA.
If it is a Roth IRA and you’ve had a Roth for five years or more, you won’t owe any income tax on the withdrawal. If it’s not, you will.
Money deposited in a traditional IRA is treated differently from money in a Roth.
If it’s a traditional IRA, SEP IRA, Simple IRA, or SARSEP IRA, you will owe taxes at your current tax rate on the amount you withdraw. For example, if you are in the 22% tax bracket, your withdrawal will be taxed at 22%.
You won’t owe any income tax as long as you leave your money in a traditional IRA until you reach another key age milestone. Once you reach age 72, you will be required to take a distribution from a traditional IRA. (The age was set at 70 1/2 until the passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act in December 2019).
The IRS has specific rules about how much you must withdraw each year, the required minimum distribution (RMD). If you fail to withdraw the required amount, you could be charged a hefty 50% tax on the amount not distributed as required.
There are no RMD requirements for your Roth IRA, but if money remains after your death, your beneficiaries may have to pay taxes. There are several different ways your beneficiaries can withdraw the funds, and they should seek advice from a financial advisor or the Roth trustee.
The Bottom Line
The money you deposit in an IRA should be money you plan to set aside for retirement, but sometimes unexpected circumstances get in the way. If you are considering withdrawing money prior to retirement, learn the rules regarding a penalty and try to avoid that extra 10% payment to the IRS.
If you think you may need emergency funds before retirement, consider putting at least some of your money in a Roth IRA so that it will be accessible without penalty if needed.