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Taxes and penalties for early withdrawals from your IRA

Posted by Andrew Chan  January 21, 2010 02:00 PM

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I have $9,400 in my IRA. What would my penalty and taxes be if I withdraw early?

While I don't have enough information about your specific circumstances to determine your tax liability, here are the rules that apply to the early withdrawal of funds from a Traditional IRA.

Withdrawals or distributions from a Traditional IRA generally consist of several components including deductible contributions, non-deductible contributions, investment earnings (including interest and dividends), and pre-tax and after-tax funds (if your IRA includes assets rolled over from an employer sponsored plan). The portion of your withdrawal/distribution that represents deductible contributions, investment earnings, or pre-tax funds are typically subject to federal and state income taxes because those amounts were not previously taxed. The portion of your withdrawal that represents non-deductible contributions or after-tax funds is not usually subject to federal or state income taxes.

The early withdrawal penalty, also called the Premature Distribution Rule, is a 10 percent federal tax that is applied to withdrawals made before age 59.5. This tax applies to the amount of your withdrawal that is subject to federal income taxes. Keep in mind that the Premature Distribution Penalty is a federal tax. Some states may also impose their own early distribution penalty for IRA withdrawals made before a certain age.

There are exceptions to the penalty under the Premature Distribution Rule. If you meet any of the following exceptions you may not have to pay the 10 percent penalty.
  • You are using the withdrawal to pay for
    • unreimbursed medical expenses in excess of 7.5 percent of your adjusted gross income, or
    • health insurance premiums for you, your spouse, or your dependents during a year in which you collected unemployment benefits for more than 12 consecutive weeks, or
    • qualified higher education expenses for you, your spouse, your children or grandchildren, or your spouse's children or grandchildren, or
    • first-time homebuyer expenses of yourself, your spouse, your children, your grandchildren, or an ancestor of your spouse or you ($10,000 lifetime limit), or
    • unpaid federal income tax liability levied by the IRS;
  • Your withdrawal is a qualified reservist distribution;
  • You make a qualifying, nontaxable rollover or direct trustee-to-trustee transfer;
  • Your beneficiary or your estate is receiving the funds from your IRA after your death (regardless of your or your beneficiary's age or your age at the time of your death);
  • You are receiving the funds due to your qualifying disability;
  • You are taking the withdrawal in the form of an annuity known as "substantially equal periodic payments".
Many of these exceptions apply to specific circumstances. Therefore, you should consult a tax adviser or review the specific rules from the IRS if you believe that any of these exceptions apply to your situation.
This blog is not written or edited by Boston.com or the Boston Globe.
The author is solely responsible for the content.

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D. Abraham Ringer is a CERTIFIED FINANCIAL PLANNER practitioner and a Financial Adviser with Morgan Stanley Global Wealth Management in Boston. He is registered in MA, NH, NY and several other states to which his articles are directed. For more information please visit www.morganstanleyfa.com/ringer
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