Traditional IRA Distribution Tax
A traditional Individual Retirement Account (IRA) is designed to encourage you to save for retirement by giving you some helpful tax breaks. You can deduct contributions from your taxes and investment earnings are not subject to income taxes while they remain in the IRA. The Internal Revenue Service has strict rules governing distributions (withdrawals) you must follow or you will incur stiff tax penalties.
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Basic Rules
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Funds contributed to or earned in a traditional IRA are not supposed to be distributed until you reach age 59 1/2, unless the funds are used for the purchase of a first home or for qualified education expenses (college tuition, for example). When you do make a distribution, the money becomes taxable income under IRS rules. Money withdrawn from a traditional IRA may not qualify for capital gains tax rates.
Exceptions
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Unforeseen events can create financial hardship for an individual or family. The IRS makes several hardship exceptions that permit you to withdraw funds without penalty, although the money withdrawn is considered taxable income. You can use traditional IRA funds without penalty to pay health insurance premiums while unemployed or to pay an IRS tax levy. You can make a distribution to pay medical expenses that exceed 7.5 percent of your adjusted gross income when they are not covered by health insurance. If you become disabled you can withdraw funds from a traditional IRA without incurring a penalty.
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Mandatory Distributions
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Distributions starting when you are 59 1/2 are voluntary. However, none of the income taxes on money in a traditional IRA have been paid. The IRS imposes mandatory distribution rules when you turn 70 1/2 so it can start collecting these taxes. At that point, you have to start withdrawing a minimum amount each year. The minimum you must withdraw is calculated to empty the account within your expected lifespan.
Penalties
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If you make an early distribution that does not qualify as an exception under IRS rules, you will be assessed a penalty tax of 10 percent of the amount withdrawn in addition to the income taxes you must pay on the money. If you fail to make minimum mandatory distributions starting at age 70 1/2, you must pay an excise tax of 50 percent of the amount not withdrawn (and pay the income taxes, as well).
Rollovers
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You may transfer funds from your traditional IRA to another traditional IRA or transfer funds in other retirement plans into your IRA without incurring penalties and retain the tax benefits as well. When you execute such a transfer or rollover, you must deposit the funds into the destination account within 60 days of withdrawing them. The IRS has strict rules you must follow, so you should consult your plan trustee or custodian before moving any funds. If you roll over funds into a Roth IRA there are tax consequences. You will have to pay any income taxes on money moved from a traditional to a Roth IRA that would have been payable had you simply withdrawn the money. However, you won't be assessed a penalty tax as long as the rollover complies with IRS rules.
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