Traditional IRAs were designed to provide an opportunity for people to save for retirement on a pre-tax, tax-deferred basis. In other words, the money grows without having to pay any taxes currently on the gains.
Withdrawing from your IRA after age 59½
Reaching the age of 59½ is one retirement milestone many people look forward to. Once you reach this age, you can begin to take your IRA distributions penalty free! At this point you can take out as much as you want, whenever you want. But these withdrawals are taxed! Every dollar you withdraw will be treated as if you earned the money during the year and taxed as ordinary income based on your current tax bracket.
Now, just because you turned 59½ doesn’t mean you have to take the money out. You may decide you do not need the income and you can wait. Withdrawals, however, must begin by April 1 following the year in which you turn 70½. But you may not want to wait until then. If you do, you will be required to take two required distributions that year. This may put you in a higher tax bracket. Taking a distribution in the year you turn 70½ will avoid this issue.
Withdrawing from your IRA before age 59½
Before retirement you can withdraw your money from an IRA any time you’d like, but you should be aware of the tax and penalty ramifications.
IRA distributions prior to age 59½ are subject to a federal 10% premature withdrawal penalty. They are also included in income and taxed as ordinary income. There are some exceptions where you can withdraw before you reach the age of 59½ where you will not be subject to the penalty.
The early withdrawal penalty does not apply to distributions that occur or are:
- Due to the IRA owner's disability.
- Due to the IRA owner's death.
- A series of "substantially equal periodic payments" made over the life expectancy of the IRA owner.
- Used to pay for unreimbursed medical expenses that exceed 7½% of Adjusted Gross Income (AGI).
- Used to pay medical insurance premiums after the IRA owner has received unemployment compensation for more than 12 weeks.
- Used to pay the costs of a first-time home purchase (subject to a lifetime limit of $10,000).
- Used to pay for the qualified expenses of higher education for the IRA owner and/or eligible family members.
- Used to pay back taxes because of an Internal Revenue Service levy placed against the IRA.
Again, these exceptions are for the 10% premature distribution penalty NOT income taxes! You still have to pay income taxes on any withdrawal you take out.
ACTION ITEM: If you are thinking of withdrawing from your IRA, consult with your CPA to fully understand the tax ramifications.
Thomas F. Scanlon, CPA, CFP ®
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