How Much Will I Get With an IRA Early Withdrawal?
The Internal Revenue Service discourages IRA owners from taking IRA distribution early with a 10 percent imposition on distributions. Early distributions are any distributions taken before age 59 1/2. Certain penalty exceptions apply. Knowing how much you get from an early distribution is contingent on the type of IRA you own, your tax bracket and whether you qualify for an exception.
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Normal Distribution Taxes
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Normal distributions out of traditional IRA accounts start after age 59 1/2, while Roth IRAs have an additional requirement. Roth IRA normal distributions need an additional five-year holding period regardless of age. Normal distributions taken from a traditional IRA add the amount taken out to your annual gross income; this is when the tax is paid on the money. Normal distributions from Roth IRAs have no tax consequence.
Your Tax Bracket
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Since normal distributions are added to adjusted gross income for the year the funds are distributed, your tax bracket determines how much in taxes you pay. The 2011 Federal Income Tax Rates range from 10 to 35 percent. When taking the money out, consider your anticipated annual gross income. For example, if you file tax returns as a single person earning $30,000 each year, you are in a 15 percent tax bracket. Assume you take out $5,000 from your IRA. You now earn $35,000, bumping your tax bracket to 25 percent. This means you pay $1,250 in income taxes. You also pay more on the rest of your annual income, going from $4,500 to $7,500 in annual income taxes on your normal earnings.
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The Penalty
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The 10 percent early distribution penalty is assessed on what you take out before you turn 59 1/2 years of age. Assuming the same $5,000 is taken out early, the total distribution is added to income tax with $500 in early distribution penalties paid. The penalty is waived if you qualify for an early penalty exception. One exception is using $10,000 of IRA funds when buying your first home. Paying college expenses at an accredited school is another exception.
A Roth IRA early distribution is treated differently; the contributions are never taxed when taking them out of a Roth IRA, but the earnings are added to income taxes and penalized on early distributions. Only the penalty is waived in exceptions, not the income tax, for either Roth or traditional IRAs.
What It Leaves
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To calculate how much you actually get with an early distribution, go back to the example of making $30,000 and taking $5,000 out of an IRA at age 40. The 25 percent taken from the $5,000 leaves $3,750. However, the 10 percent is calculated on the total $5,000, so $500 is subtracted from $3,750, leaving $3,250. Keep in mind you are paying more in personal income taxes too.
The previous example is from a traditional IRA; the Roth yields different results. Assume the $5,000 is part of contributions; then there is no tax on it at all. Assume that only $4,000 is contributions; then $1,000 is added to income with a $150 income tax if you remain at the 15 percent bracket. There is a $100 penalty. The $5,000 distribution then gives you $4,750. All these numbers don't factor state taxes, which vary from state to state ranging from 0 to 11 percent. Roth IRAs do not pay state income tax.
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