Tax Deferrals For IRA Withdrawals
IRAs allow investors to defer taxes until withdrawing funds or earnings; however, any withdrawal may come with a 10% penalty fee unless certain criteria are met.
One IRA rollover per year may be performed, which involves physically withdrawing and depositing money within 60 days to avoid taxes on an early distribution.
Taxes on IRA Withdrawals
In general, any money withdrawn from an IRA prior to age 59 1/2 must be subject to ordinary income tax unless another exception applies; such as using it to purchase your first home or pay high medical costs or in other unusual situations where no penalty applies.
Your taxable withdrawals can also vary based on whether or not you own traditional or Roth IRAs, and when contributions were made. Typically, if funds are withdrawn before age 59 1/2 from a traditional IRA, the IRS will assess an early withdrawal penalty of 10% of funds withdrawn early.
The exceptions to the penalty rule are quite broad, but may include: A first-time home purchase, qualified higher education expenses for yourself, your spouse and/or children as well as unreimbursed medical expenses that exceed 7.5% of adjusted gross income, financial losses from federally declared disasters as well as substantially equal periodic payments over your life expectancy to satisfy a government-imposed requirement and expenses associated with birth or adoption expenses may all qualify as exceptions to it.
Taxes on Roth IRA Withdrawals
Roth IRA contributions are made using after-tax dollars, making withdrawals without incurring taxes or penalties an attractive retirement benefit. You must wait at least five years since making your initial contribution before withdrawing investment earnings tax-free and without incurring penalties or taxes.
If you withdraw money before five years have passed, income taxes and an early withdrawal penalty of 10% will apply, unless there are exceptions applicable to you such as purchasing your first home, becoming permanently disabled, or using it for educational purposes.
If you want to avoid paying taxes when withdrawing from a Roth IRA, only withdraw investment earnings and not contribution amounts. Another way is to rollover withdrawals into another IRA account held with the same financial institution, though doing this requires careful record-keeping and coordination with your trustee. Alternatively, make a trustee-to-trustee transfer when moving assets between accounts.
Taxes on Traditional IRA Withdrawals
For certain reasons, the IRS allows you to withdraw money from a traditional IRA without incurring an early withdrawal penalty. For instance, up to $10,000 of your lifetime limit may be used penalty-free when purchasing your first home – whether that be yourself, a spouse, or child.
Your IRA also allows you to draw down on medical expenses that exceed 7.5% of your adjusted gross income without incurring penalties, and take out up to $5,000 without penalty for adoption or birth costs.
However, any withdrawal that does not meet one of these exemptions will still incur taxes; traditional IRA withdrawals count as income and could push you into higher tax brackets. Therefore, before withdrawing funds from your traditional IRA between 55-65, carefully consider your options and all possible outcomes before taking any actions.
Taxes on Rollovers
Rollover IRAs can often be tax-free if performed properly. Direct rollovers involve your current plan making payments payable directly to the new IRA provider; typically through cutting a check to Acme Bank “for the benefit of John Doe’s Rollover/Traditional IRA”.
In an indirect 60-day rollover, your old retirement account usually provides you with a check with taxes withheld, which must be deposited into an IRA within 60 days or it will be taxed at ordinary income rates and subject to an additional 10% penalty if you are under age 59 1/2.
Due to IRS tax law, any distribution that you don’t roll over as a rollover distribution is considered taxable and it is important that you carefully consider all available options before moving money from one retirement plan to another. Furthermore, only one rollover per year is permissible.
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