The answer is no—if it's done properly. You can move the funds by means of a trustee-to-trustee transfer to another IRA, or roll over the amount to your 401(k). You would need to check with your current employer or the 401(k) plan's administrator to determine if it will allow the rollover first, of course. This way, you will keep the amount in your retirement nest egg and continue to defer paying income tax on the amount.
- Both traditional IRAs and Roth IRAs have early withdrawal penalties unless certain rare exceptions are met, for withdrawals prior to age 59½.
- Traditional IRA funds are taxed upon withdrawal at the rate determined by your ordinary income tax bracket.
- Withdrawals of prior contributions to Roth IRAs are tax-free as long as the account has been open for 5 years or more, but earnings are still subject to taxes.
- The CARES Act has waived the penalty on early withdrawals from retirement accounts for anyone directly affected by the coronavirus pandemic, but it is not without its drawbacks.
Withdrawals, Tax Brackets, and Penalties
Traditional IRAs will be taxed at the time of withdrawal regardless of your age when you take money out of the account. This is because you received deductions in past tax years when contributing to your traditional IRA account. If you withdraw the full balance from the account and close it out, it will be taxed as ordinary income based on your tax bracket.
Also, the Internal Revenue Service (IRS) imposes an early withdrawal penalty of 10% for withdrawing your IRA if you're under the age of 59½. There are rare exceptions to this penalty rule, including a one-time $10,000 withdrawal allowed for the purchase of a first home. As always, be sure to speak with a qualified tax professional to confirm your situation qualifies for an exception in order to avoid a hefty tax liability and penalties.
The rules are different if you have a Roth IRA. Because you contribute to your Roth IRA on an after-tax basis, the contribution portion is tax free at withdrawal. You can close your Roth account without negative consequences if your total account balance is less than the accumulated amounts you deposited as regular contributions. Essentially, this means your Roth IRA decreased in value over time.
Any earnings in a Roth IRA are subject to taxes unless specific criteria are met. To qualify for tax-free distribution of earnings from a Roth IRA, you must be at least 59½, permanently disabled, or taking out no more than $10,000 to spend on first-time home ownership. Additionally, five years must have passed since your first contributions into the Roth IRA in order to be eligible.
If you withdraw funds early, you will likely be subject to taxes on the earnings portion of your Roth IRA, as well as a 10% early withdrawal penalty on that same amount. There are rare exceptions, so you should speak with a qualified tax professional about your own unique situation.
For example, assume you contributed a total of $20,000 to your Roth IRA, which is now worth $30,000. If you close out your Roth IRA early at the age of 42, for a reason not deemed an exception, you would be able to take the first $20,000 tax-free because you never received a deduction for that portion in past tax years. However, the $10,000 gain in value would be taxed and assessed the early withdrawal penalty.
In the event of the IRA owner's death, beneficiaries under the age of 59½ can access the funds without an early withdrawal penalty. This applies to both traditional and Roth IRAs. See this article for more information and rules surrounding withdrawals from inherited IRAs.
Special Considerations: COVID-19 and CARES Act
The Coronavirus Aid, Relief, and Economic Security (CARES) Act has added additional exemptions to allow IRA owners to take withdrawals for emergency expenses related to the coronavirus pandemic. This allows a partial deferral of the tax penalties. The plan allows you to take special disbursements from your IRA or 401(k) in an amount up to $100,000 without facing an immediate tax penalty of 10% on the early withdrawal. You would be able to repay the distributions over the next three years and be allowed to make extra contributions for this purpose.
As always, be careful about withdrawing from your retirement account! Although the early withdrawal penalties may be waived temporarily, taxes are still due on withdrawals. Additionally, the funds used for emergency coronavirus purposes have to be paid back within 3 years. Be sure to use this only as a last resort.
These measures apply to anyone directly affected by the disease itself or anyone who faces economic hardship as a result of the pandemic. For example, this includes anyone who has been furloughed, laid off, lost childcare, or had a reduction in hours at work due to the pandemic.
However, be careful before you choose to take funds out of your retirement account. This only removes the 10% early withdrawal penalty; any withdrawals from a traditional IRA or the earnings portion of a Roth IRA are still subject to income tax.