IRA Withdrawal

For most individuals, IRA accounts represent a relatively secure method of planning for retirement. The first IRA withdrawal typically occurs when the individual retires, sometime after he or she reaches age 59 and 1/2 years; significant IRA withdrawal penalties usually apply prior to that date. IRA accounts are designed to provide a tax-deferred way for individuals to save for retirement; as such, they are not meant to be used as a source of ready income or to handle temporary financial difficulties. IRA withdrawal penalty regulations are actually intended to protect the funds available for retirement. They do so by discouraging account owners from making withdrawals that cannot be easily replaced under current IRA account rules and may affect the overall amount available when the account holder reaches retirement.

IRA withdrawal penalties

All IRA withdrawals are generally subject to tax unless they are distributed from IRA funds that have already been taxed before contribution; this IRA withdrawal tax is assessed at the account holder’s current percentage rate. This applies to distributions both before and after the individual reaches the age of 59 and 1/2. However, additional penalties may apply for withdrawals taken before age 59 and 1/2 years; this early IRA withdrawal penalty usually amounts to 10% over and above the regular tax payable on the distribution. In most cases, the financial loss presented by taking early distribution from IRA accounts outweighs any temporary financial purpose served by these withdrawals.

Avoiding an IRA withdrawal penalty

Fortunately, there are a few special situations in which early IRA withdrawals can be accomplished without incurring the early IRA withdrawal penalty. These include:
  • A withdrawal of $10,000 for the purchase of a first home
  • Qualifying educational expenses
The exception for purchasing a first home is especially useful since it can be used by any individual or couple who did not own a primary residence during the previous two years. Additionally, both members of a couple can qualify for this exception to IRA withdrawal penalties; each can withdraw $10,000 for a total of $20,000 toward the purchase of a principal residence. In order to take advantage of this method for avoiding IRA withdrawal tax penalties, the homebuyers must take possession of the home within 120 days of the date of distribution and the funds must be applied directly to the cost of the new home.

IRA withdrawals for educational expenses may be used to pay for tuition and fees, books, and room and board for full-time students. It may be used for the account holder, his or her spouse, or the children or grandchildren of the owner of the IRA, and the school must be an accredited postsecondary institution.

Other exceptions

There are a few other specialized situations in which IRA withdrawals may be made without incurring tax penalties. Rollovers from one IRA account to another are allowed once per twelve-month period, but must be replaced within sixty days; this limits the utility of this technique. The most common type of IRA withdrawals, of course, are the monthly or annual distributions made to the account holder upon retirement. Because retirement income is often considerably less than the income earned by working individuals, the tax bracket of retired persons is usually lower, allowing an overall tax savings for IRA investors during their retirement years.
Tim Ord
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