What Are the Rules for Cashing in an IRA?
People with traditional IRAs must begin taking required minimum distributions (RMDs) as soon as they turn 72; RMDs are part of the government’s measure to ensure that money doesn’t remain tax-deferred forever.
There may be exceptions, such as withdrawing an IRA withdrawal to use as a down payment on a home, but before doing so, carefully consider your options before taking that money.
Taking Money Out of an IRA
As its name implies, an Individual Retirement Account (IRA) is designed for use during retirement. As such, the IRS imposes a 10% penalty if money is withdrawn before age 59 1/2 – this amount must also be subject to income taxes that will need to be paid.
However, there are exceptions to this rule. The IRS allows distributions without incurring the 10% penalty if they’re used to cover qualified higher education expenses, buy your first home, or cover health insurance premiums when unemployed.
Other exceptions could be making payments that exceed 7.5% of your adjusted gross income or helping out a family member facing financial strain. Before withdrawing money from an IRA to pay debts, consider alternatives first – for instance, its assets tend to be protected against creditor claims other than bankruptcy proceedings; should this situation arise for you, consult with an experienced tax advisor for guidance.
Taxes
Traditional IRAs provide tax-deferred growth over time; however, at some point they must be distributed. This rule is known as the required minimum distribution (RMD). When withdrawing money from an IRA you may owe taxes and penalties as well.
IRS rules allow certain people to withdraw penalties-free withdrawals from an IRA in certain instances, such as paying medical expenses that exceed 7.5% of your adjusted gross income or when unemployed and needing the money for health insurance premiums for 12 consecutive weeks.
Avoiding the 10% early withdrawal penalty can also be achieved through making periodic distributions calculated according to IRS-approved methods, such as the annuitization method or uniform life expectancy table. Distributions should continue until either you reach age 59 1/2 or the account owner dies; whichever comes first.
Penalties
Tax advantages associated with investing money in an IRA come at the price of incurring an early withdrawal penalty of 10% of any withdrawal made prior to retirement eligibility. There may be certain exceptions where you can withdraw funds without incurring this charge; please see here for more details.
For home purchases, distributions may be used without penalty to purchase, build, or rebuild within 120 days and for “qualified acquisition costs.” In the case of medical expenses exceeding 7.5% of adjusted gross income, however, an exception exists where distributions can be used without paying a penalty.
Thirdly, if you are totally and permanently disabled or the beneficiary of a deceased IRA owner. Furthermore, taking required minimum distributions (RMDs) each year starting April 1 of the year after you turn 70 can also help avoid penalties.
Taking Money Out of a Roth IRA
Roth IRA withdrawals can be taken tax-free provided they meet IRS rules. These differ from traditional IRA rules which stipulate an initial RMD must be taken by April 1 of the year following when reaching RMD age, with annual withdrawals made before December 31.
Roth IRAs do not require you to withdraw earnings until retirement age; any withdrawals prior to this point could incur taxes and possibly penalties.
To qualify for penalty-free withdrawal of Roth IRA earnings, contributions must have been made at least five years before withdrawing them and you must be at least 59 1/2. There may also be exceptions such as withdrawing to purchase your first home or unreimbursed medical expenses that exceed 7.5% of adjusted gross income; check with your IRA provider for more information.
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