There are no tax penalties for closing an Individual Retirement Account (IRA)—as long as it's done properly.
You can transfer the money into another IRA. Or, if you have an employer-sponsored 401(k), you can roll over the money into it. (Check first to make sure your employer or 401(k) plan administrator permits this.)
In either case, your money will still be reserved for your retirement future, and any income tax you owe on it will be deferred.
- Traditional IRAs have early withdrawal penalties prior to age 59½, with certain exceptions.
- Money withdrawn from a traditional IRA early also is fully taxable as ordinary income.
- The money you pay into a Roth IRA may be withdrawn early without paying a penalty or taxes if the account has been open for five years or more.
- The earnings in your Roth IRA cannot be taken early without incurring a penalty and taxes.
- There is some relief from early withdrawal penalties for taxpayers affected by the coronavirus pandemic.
Withdrawals, Tax Brackets, and Penalties
Money withdrawn from a traditional IRA is taxed in the year in which it is withdrawn regardless of your age when you take money out. So, 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.
In addition, the Internal Revenue Service (IRS) imposes an early withdrawal penalty of 10% for withdrawing money from an 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.
To be on the safe side, speak with a qualified tax professional to confirm your situation qualifies for an exception.
The rules are different if you have a Roth IRA, because you pay income taxes on the money in the year during which you deposit it. The money, including the profits on your contributions, will be tax-free when you withdraw it if you follow the rules.
To qualify for tax-free distribution of earnings from a Roth IRA, you must be at least 59½ years old, permanently disabled, or taking out no more than $10,000 to spend on first-time homeownership. Five years must have passed since your first contributions into the Roth IRA.
It's trickier if you're taking money out early.
Withdrawing Roth Money Early
You can take out the money you contribute at any time. Remember, you already paid the income taxes on that money.
Taking out the earnings without negative tax consequences is trickier.
If you withdraw money early, you will likely be subject to taxes on the earnings portion of your Roth IRA plus a 10% early withdrawal penalty on that same amount.
For example, assume you contributed a total of $20,000 to your Roth IRA, and the account has grown to $30,000. If you close out your Roth IRA early, say at the age of 42, for a reason not deemed an exception, no additional taxes will be due on the first $20,000. However, the $10,000 gain in value would be taxed and assessed the 10% early withdrawal penalty.
There are rare exceptions to the rules, so you should speak with a tax professional about your own unique situation.
If You Inherit an IRA
In the event of an IRA owner's death, the beneficiaries can access the funds without an early withdrawal penalty, regardless of their ages. This applies to both traditional and Roth IRAs.
In short, this is no longer a retirement account; it's inherited money. The tax rules for inherited accounts are different.
Special Considerations: COVID-19 and CARES Act
The Coronavirus Aid, Relief, and Economic Security (CARES) Act has added special exemptions that allow IRA owners to take withdrawals for emergency expenses related to the coronavirus pandemic.
The plan allows affected taxpayers to take special disbursements from an IRA or 401(k) in an amount up to $100,000 without facing an immediate tax penalty of 10% on the early withdrawal.
The account holder can repay the distributions over the next three years and will be allowed to make extra contributions for this purpose.
Remember: If you take an early withdrawal, even for an allowable exception, you'll still owe income taxes on money you withdraw from a traditional IRA or 401(k). If it's a Roth IRA, you'll owe income taxes on any earnings you withdraw early.
These measures apply to anyone who faces economic hardship as a result of the pandemic. For example, it includes anyone who has been furloughed, laid off, lost access to childcare, or had a reduction in hours at work due to the pandemic.