Rules for IRA Withdrawal

By W D Adkins

  • Overview

    Many people open Individual Retirement Accounts (IRAs) either because they do not have an employer-provided 401k or to add to their retirement savings. However, the IRS sets strict rules for withdrawal of funds from IRAs, which vary depending on the type of account. An early withdrawal or failure to make required distributions upon reaching retirement can result in costly penalties.
  • Types

    There are two basic types of IRAs, the traditional, and the Roth. Anyone who has earned income can open an IRA with the sole exception that you must be less than 70½ years old to open a traditional IRA. Contributions up to $5,000 ($6,000 as of 2008 for those over 50) are allowed. The traditional IRA is a tax-deferred account---you can deduct the contributions up front and pay taxes on contributions and earnings only when funds are withdrawn. The Roth IRA has no up-front deduction, but earnings are exempt from taxes if withdrawn in accordance with IRS rules. With both traditional and Roth IRAs, you must be 59½ to make withdrawals without penalty, with some exceptions. Employer-provided and self-employment IRAs (SIMPLE and SEP) largely follow the rules for traditional IRAs.
  • Roth IRA

    Rules for IRA withdrawal from a Roth IRA allow contributions to be withdrawn at any time since they are not tax deferred. Earnings must stay in the account until after the fifth year of the account's existence (including the tax year for which contributions are initially made) and either the account owner turns 59½ or an allowed exception applies. Exceptions are made if the Roth IRA owner is disabled or for the purchase or repair of a first home up to a lifetime limit of $10,000. A beneficiary who inherits a Roth IRA can withdraw the funds without penalty.

  • Traditional IRA

    In a traditional IRA, contributions are tax deductible but must remain in the account until age 59½. Exceptions are similar to those for a Roth IRA, with some additions. Annuity payments may be withdrawn. Funds may also be withdrawn to pay for unreimbursed health care costs if they exceed 7.5 percent of gross income or for certain qualified educational expenses. There is no upper limit for funds used to purchase a first home.
  • Features

    Money in a Roth IRA may be left there as long as desired. This is not the case for a traditional IRA. Beginning on April 1 of the year after the IRA owner turns 70½, a minimum disbursement is required. The size of the minimum disbursement depends on the amount in the account and the individual's life expectancy. Rollovers are allowed to or from both Roth and traditional IRAs if the funds are deposited within 60 days of being taken from another retirement account.
  • Penalties

    In general, an early withdrawal that is not in compliance with IRS rules is subject to regular taxes in the year it is made, plus a 10-percent penalty. This can be especially expensive with a Roth IRA where earnings would normally pay no taxes at all. In a traditional IRA, if all or part of a minimum required disbursement is not made, it is subject to a 50-percent excise tax. Funds may be "borrowed" from a traditional IRA for up to 60 days for some purposes such as buying a home, but must be returned within the time limit or be considered a premature withdrawal.
  • Considerations

    The IRS advises in its guidelines (Publication 17; see "Additional Resources," below) to exercise caution when making rollovers to IRAs. A failed rollover will be considered a premature withdrawal and subject t o applicable taxes and penalties. There are some types of investments that are prohibited in IRAs, including most collectibles (like rare coins). If investment is made in a prohibited category, it will be considered a premature withdrawal subject to taxes and penalties.
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