What Happens When You Make An Early IRA Withdrawal IRA
While you may be planning to keep funds hidden in your retirement accounts until you are financially ready to quit your job, life can waste your time. If you’re strapped for cash before retirement, one way to support your household might be to make an early withdrawal from your individual retirement account. However, withdrawing money from an IRA early can have significant financial consequences. Early withdrawal from the IRA may result in penalties and taxes.
Here’s what to consider before taking an early IRA withdrawal:
- There is a 10% early withdrawal IRA penalty.
- There are several exceptions to the early withdrawal penalty if you are using the money for specific purposes.
- You have to pay income tax on an early withdrawal from the IRA.
- There might be better ways to pay for an unexpected expense.
Here’s a breakdown of what to expect when making an early withdrawal from your IRA.
What is an early IRA withdrawal?
An IRA is set up with retirement and long-term savings in mind. When you contribute to an IRA, the funds can be placed in investments where they have the opportunity to generate income over time. When you reach the age of 59 1/2 you are allowed to make withdrawals from the account without any penalty. If you withdraw funds before you are at least 59 and a half years old, the action is considered an “early withdrawal”. After age 72, you must withdraw the minimum required distributions from the account.
Penalty for early withdrawal of the IRA
If you withdraw funds from an IRA before you reach age 59 1/2, you can expect some financial repercussions. “You will be charged a 10% penalty on funds withdrawn,” says Colton Castleman, retirement advisor at Assurance & Guarantee in Burlington, North Carolina. “This amount will be deducted from the amount withdrawn.” If you withdraw $ 10,000, you can expect the penalty to be 10% of that amount, or $ 1,000.
The penalty means you will have to withdraw more than necessary to cover an expense. For example, if you have a bill for $ 10,000, you will need to withdraw more than $ 10,000 to cover the penalty that will be incurred and still have enough for payment.
Tax implications of an early IRA withdrawal
When you withdraw funds from your IRA, the amount will be considered part of your income for the year. This means that the amount will be subject to income tax. If you are in the 24% tax bracket and withdraw $ 20,000, the taxes for the withdrawal could be $ 4,800 (24% of $ 20,000). With that in mind, you will need to withdraw enough money to cover the taxes you will need to pay on the withdrawal while also paying the expenses you are facing.
Avoid the IRA early withdrawal penalty
When you collect funds before the age of 59 1/2, there are several cases in which the usual penalty may be waived. For example, you can set up a series of regular withdrawals from the account that will not trigger the early withdrawal penalty.
You generally won’t need to pay the IRA early withdrawal penalty if you use the money to:
- Medical expenses greater than 10% of your adjusted gross income.
- Health insurance premiums during unemployment.
- Costs associated with buying a first home, typically up to $ 10,000.
- Tuition and other higher education costs.
- The birth or adoption of a child, up to a maximum of $ 5,000.
- A severe handicap.
Although you can avoid the early withdrawal penalty, you will still owe income tax on the distribution. “These types of withdrawals are still considered gross taxable income, but no penalties are imposed and you don’t have to pay them back,” says Castleman.
Considerations Before Taking an Early IRA Withdrawal
Since IRAs are designed for long-term savings, withdrawing early usually has implications. “Early withdrawals have little benefit unless you have a hard time or some other immediate need that requires you to need money,” says Rob Williams, vice president of financial planning, retirement income and wealth management at the Schwab Center for Financial Research.
You may want to consider other ways to cover unforeseen expenses, such as a loan or a budget adjustment. In an emergency, it may be necessary to make an early withdrawal, which could include a penalty waiver if you qualify. “While flexibility has its benefits, it’s important to remember that your IRA savings are meant to benefit you in the long run and that an early withdrawal can minimize the potential gains on your income,” Williams says.