Early Withdrawal Tax from a Traditional IRA
Traditional IRAs have the individual retirement account market cornered. About 36.6 million U.S. households own traditional IRAs, comprising an 88 percent share of all IRAs held, according to the Investment Company Institute. Traditional IRAs provide investors an up-front tax benefit, but like all IRAs, if you withdraw money too soon, and don't follow IRS rules, you'll end up paying a penalty.
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Function
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When Congress initiated IRAs they intended them as retirement savings vehicles. As the years since 1974 passed, the game changed, triggering regulations that allow for broader use of IRA money. You can use IRA money to not only fund retirement, but to pay for college or up to $10,000 worth of first-time home buyer expenses, without prompting an IRS tax penalty on early withdrawals.
General Tax Implications
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When you tap into a traditional IRA, the IRS requires you to report the distribution and pay regular income tax on the entire amount, regardless of age or circumstance. Because the IRS does not tax your IRA contributions -- in fact, Uncle Sam allows you to deduct contributions from your taxable income, up to a limit, every year -- it makes sure it generates an income tax bill when you cash out of a traditional IRA. If you cash out prematurely -- before you turn age 59-1/2 -- the IRS generally dings you with an additional penalty for early withdrawal.
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10 Percent Tax Penalty
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If you take a non-qualified distribution from a traditional IRA, the IRS charges the 10 percent tax penalty in addition to regular income tax due. Non-qualified distributions from traditional IRAs occur prior to the IRS retirement age of 59-1/2. Not all early distributions trigger the penalty, however.
Exceptions
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The IRS allows traditional IRA holders to access their money early to pay for college for themselves, their spouse, their kids or their grandkids; to fund first-time home buyer expenses for the same group of people; or to satisfy an IRS levy. You also skirt the 10 percent penalty if you withdraw traditional IRA money after you become disabled; to cover non-reimbursed medical expenses that exceed 7.5 percent of your adjusted gross income; to pay medical insurance premiums; as annuity payments; or if you are the beneficiary of a deceased IRA owner's account.
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