About Penalties for Terminating an IRA Account

By John Hewitt

  • Overview

    About Penalties for Terminating an IRA Account
    Companies that provide individual retirement accounts (IRAs) apply a small termination fee for every account closed. For most service providers, this fee doesn't exceed $50. The real penalties only accrue when someone liquidates investments and withdraws money early from an individual retirement account, which tends to result in significant fees and tax disadvantages.
  • Significance

    If an individual retirement account is empty, there are no additional fees aside from the termination expense itself. If the account holder wants to avoid any significant early withdrawal penalties, they will need to transfer or rollover the money into another IRA either at the same company or at another legally authorized institution. Rollovers involve withdrawing the money from the account, taking a receipt, and investing it in another IRA within 60 days. Transfers are direct movements of assets from one account to another.
  • Expert Insight

    One commonly overlooked feature of the tax code is that if the IRA holder uses the money from an early withdrawal to pay for tuition at an accredited educational institution. Although for tax purposes, it's better to use a 529 account to save over the long term for college, if an individual wants to terminate their IRA account, using the money to pay for tuition is a great way to avoid paying the tax penalties and needing to report it as additional income.

  • Considerations

    IRS Publication 590, linked below in the resources, details the early withdrawal IRA tax penalty. Any early withdrawal is subject to a tax penalty of 10% of the amount withdrawn and it counts as taxable income .There are exceptions to this rule, however. Aside from the education exception mentioned before, if it's used for medical expenses exceeding 7.5% of adjusted gross income, it's not subject to those penalties. Also, someone in the household dies, the individual becomes disabled or is purchasing a first time home, withdrawals aren't penalized.
  • Effects

    Terminating an IRA account before it enters maturity can end up being a serious mistake. In many cases, it may be a better long-term financial decision to take out a loan rather than to raid an IRA for funds. In addition to the penalties, the if the person who terminated the account earlier wants to build it back up again, they are still limited by the maximum annual contribution regulations, and it could take years to build the account back up to its former level.
  • Warning

    Before opening an IRA account, be sure to examine any additional transfer, rollover or termination fees involved in the account. As IRAs are often very long term investments, when opening them it can be difficult to predict the needs of the future. For example, the account holder may decide much later on that they would like to close their IRA and roll it over into an annuity plan for greater simplicity and security.
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