How to Cash out of a Traditional IRA

Looking for some extra cash?

Cashing out a Traditional Individual Retirement Account or IRA requires following step-by-step instructions in order to receive funds from your Traditional IRA account. These guidelines are for people younger than 59½ . Anyone over this age must follow different guidelines for IRA fund distribution. This article will help you determine if you should cash out your IRA, the risks and benefits of cashing out and the actual steps to take.

Things You'll Need

• Recent Traditional IRA statement
• Calculator
• Blank paper
• Pencil
• Phone number for institution holding IRA
• Address and account number for where you would like funds deposited

Instructions

1. First determine if any of your IRA is a "qualified distribution." A "qualified distribution" is cashing out an IRA without receiving any tax penalties. If your distributions are considered qualified they may not be subject to taxes if: 1) You deposited the 2008 economic stimulus payment into IRA and are now withdrawing the amount you deposited; 2) You are a qualified reservist; and 3) If the IRA is over five years old AND one of the following: a) Used to buy or rebuild your first home; b) You are disabled; c) You received this IRA as part of an inheritance; d) You have qualifying medical expenses; or e) You have qualifying higher education expenses. If you meet these requirements - go to Step 5.

2. Did you already contribute funds to your IRA this year? Contributions made in the current tax year can be withdrawn before taxes are due without any tax penalty. If filing for an extension for your taxes, these specific IRA contributions can be withdrawn tax free up until the final tax extension date.

3. Make sure you have a traditional and NOT a Roth IRA. Traditional IRAs are treated differently as funds are taken out pre-tax or before income taxes. Unless funds are considered a qualified expense, all funds cashed out of a traditional IRA are subject to the 10 percent penalty. For example, a traditional IRA account is six years old, the holder has been depositing $3,000 each year. The total contributions currently equal $18,000. The balance of funds in the traditional IRA is $25,000, in six years you have earned $7,000. If the $25,000 does not meet the "qualified distribution" test, the amount withdrawn, say $25,000 would be subject to a 10 percent penalty. After the 10 percent penalty, the remaining funds would be taxed as income.

4. What does the 10 percent penalty and taxes mean to a traditional IRA? Any cash removed from a traditional IRA is subject to a 10 percent tax if it is not considered a "qualified distribution." Using the example above with a six-year-old account, an $18,000 total investment, a current balance of $25,000, indicating an earnings of $7,000. Multiply the amount of cash to withdraw by 0.10. Example: If $25,000 is being cashed out and none of these funds are a qualified expense. Calculate as follows: $25,000 * 0.10 = $2,500. So to when cashing out $25,000 you will lose $2,500 in penalties, bringing the amount down to $22,500.

5. Now where do income taxes come into play? Remember that in a traditional IRA the entire $22,500 is subject to income taxes. A person in the 28 percent income tax bracket, withdrawing the entire $25,000, will be taxed approximately an additional $6,750. So, from your initial $25,000 withdrawal, you forfeit $2,500 in early withdrawal penalties and pay around $6,750 in income taxes. Out of the $25,000 you will lose a total of $9,250 leaving you with approximately $15,750.

6. Has your IRA lost value beyond what you invested? It is worth noting that any losses in IRA value past what you invested may be deducted on your taxes if you cash out. In the year you take the distribution or "cash out" if your IRA lost value beyond what you invested each year, you may be able to deduct this amount on your taxes. CHECK WITH YOUR TAX PROFESSIONAL. This is subject to the 2 percent-of-adjusted-gross income limit that applies to some deductibles.

7. Determine how much to cash out. Some IRAs allow for partial distributions. To determine if your IRA qualifies, call the institution that holds your IRA.

8. Cashing out: What's next? Next contact the institution holding the IRA and tell the representative you are cashing out. They will mail the forms needed to be filled out. Institutions will also allow you to fill out forms at their locations. Go in person to pick up the forms and remember to bring an ID. Fill out the forms and give them back to the institution holding the funds. These forms will often ask for the account where the final funds are to be transferred. Double and triple check these account numbers so the money goes into the right account.

9. Now you wait. Depending on what the IRA is invested in, it may take a few days to unwind these transactions. Ask your adviser when you should expect these funds to be deposited or when a check will be mailed.

10. Receive the funds. The entire $25,000 will be withdrawn, but remember these funds received from an IRA are going to be taxed at the end of the year. So it would be wise to hold back enough to pay taxes.

Tips & Warnings

• If you decide not to cash out the Traditional IRA it might be time to consider rolling it into a Roth IRA. If given a choice between withdrawing from an IRA or a 401k -- look closely at the 401k options. Funds can be borrowed from a 401k, they will have to be paid back over time, but funds may not incur a tax penalty. Check with your employers benefit office to see if you qualify. Instead of borrowing from your 401k, you may also take a hardship withdrawal. Again see your employers benefit office for details.

• IRA funds should only be withdrawn as an absolute last resort. Another alternative would be to stop funding the IRA for awhile. The loss in penalties and taxes from cashing out an IRA do not compare to the potential long-term gains if it is left alone. If you are close to 59½ you might have to think twice about cashing out. You do not incur the 10 percent penalty at this age, but you will have tax consequences. It is best to check with a tax professional if you are close to 59½ and are looking for extra cash options.