Most financial experts would agree that it is rarely, if ever, a good idea to take an early withdrawal from a traditional IRA or Roth IRA. This is due in part to the high cost of penalties that can hit an account holder for an early withdrawal (not to mention losing out on years of potential earnings).
Early distributions from IRAs, or individual retirement accounts (that is, those made before age 59½), generally incur a 10% tax penalty, plus you may owe income tax on it. The Internal Revenue Service (IRS) imposes the penalty to dissuade IRA holders from using their savings before retirement. But the penalty only applies if you withdraw taxable funds.
If you withdraw funds that are not subject to income tax, there is no penalty for distributions taken at any time. Whether funds are taxable comes down to what type of IRA you own.
- If you take an early withdrawal from a traditional IRA—whether it’s your contributions or earnings—it may trigger income taxes and a 10% penalty.
- You can withdraw Roth individual retirement account (Roth IRA) contributions at any time with no tax or penalty.
- If, however, you withdraw earnings early from a Roth IRA, you may owe income tax and a 10% penalty.
- Some early withdrawals are tax free and penalty free.
Traditional IRA Withdrawal Penalties
To calculate the penalty on an early withdrawal, simply multiply the taxable distribution amount by 10%. For example, an early distribution of $10,000 would incur a $1,000 tax penalty, and it would be treated (and taxed) as additional income.
Early distributions from traditional IRAs are the most likely to incur heavy penalties. Contributions to this type of account are made with pretax dollars. Your contributions are subtracted from your taxable income for the year, effectively reducing the amount of income tax that you’ll owe.
You get an up-front tax break when you contribute to a traditional IRA, but you’ll pay taxes on your withdrawals in retirement. In general, this means that the entirety of your traditional IRA balance is composed of taxable income. Therefore, if you withdraw funds before age 59½, the 10% tax penalty likely applies to the full amount of the distribution.
After accounting for the impact of income taxes and penalties, an early distribution from a traditional IRA is rarely an efficient use of funds.
Roth IRA Withdrawal Penalties
Contributions to Roth IRAs are made with after-tax dollars. This means that you pay income tax on your contributions for the year when you make them. As a result, withdrawals of Roth contributions are not subject to income tax, as this would be double taxation.
If you take out an amount equivalent to the sum that you put into your Roth, the distribution is not considered taxable income, regardless of your age, nor is it subject to penalty.
If you withdraw an amount above that—meaning that you start dipping into the account’s earnings—that amount is generally considered taxable income. It also may be subject to the 10% early distribution penalty, and the money would be treated as income.
There’s no up-front tax benefit for Roth IRA contributions, but earnings grow tax free, and withdrawals in retirement are tax free as well.
Roth IRA Withdrawal Pros and Cons
You can always withdraw Roth IRA contributions (not earnings) tax free and penalty free.
You may be able to avoid the tax and penalty on early withdrawals in certain situations.
If you don’t have any other options, it can be comforting to know that your IRA is there for you.
Early withdrawals of earnings (not contributions) from a Roth IRA can trigger tax and a 10% penalty.
Unless you remove and return money to an IRA within 60 days, you can’t “pay back” the money to your IRA once you take it out.
If you take money out of your IRA, you’ll miss out on years (or decades) of growth.
How Qualified Distributions Work
Qualified distributions from a Roth IRA are tax free and penalty free. The IRS considers a distribution to be qualified if it has been at least five years since you first contributed to a Roth IRA. The withdrawal is as follows:
- Made when you’re age 59½ or older
- Taken because you have a permanent disability
- Made by your beneficiary or estate after you pass away
- Used to buy, build, or rebuild a home that meets the first-time homebuyer exception
Non-qualified distributions are any withdrawals that don’t meet these guidelines. For these withdrawals, you’ll owe taxes at your ordinary income tax rate (remember, it just applies to earnings) and a 10% penalty.
Still, certain exceptions apply. You can get out of the penalty (but not the tax) if you take the distribution for the following:
- A series of substantially equal distributions
- Unreimbursed medical expenses that exceed 10% of your adjusted gross income (AGI)
- Medical insurance premiums after losing your job
- An IRS levy
- Qualified reservist distributions
- Qualified higher education expenses
Borrowing from a Roth IRA
While you can’t borrow from a Roth IRA as you can from a 401(k), you can temporarily borrow funds as long as you return them to the same Roth IRA or a traditional IRA within 60 days. This is known as a rollover. There are very stringent requirements for doing this—including that you can only do one Roth rollover in a year—so work with your financial institution to make sure that your short-term loan isn’t treated as a non-qualified distribution.
Special COVID-19 benefits under the Coronavirus Aid, Relief, and Economic Security (CARES) Act—which applied only to the 2020 tax year—allowed account holders to borrow up to $100,000 from their IRAs and repay them within three years without a penalty.
Tax Implications for Roth IRAs
There is yet another loophole for earnings on Roth contributions. If you contribute and then withdraw within the same tax year, then the contribution is treated as if it were never made.
For example, if you contribute $5,000 in the current year and those funds generate $500 in earnings, you can withdraw the full $5,500 penalty free, as long as the distribution is taken prior to your tax filing due date. However, you would have to report those earnings as investment income.
Investors have the option of converting their traditional IRA to a Roth IRA. There are many benefits to converting, such as no required minimum distributions (RMDs) within the account holder’s lifetime. The benefit of converting also depends on your tax bracket. If you do convert, you will have to pay taxes on the amount that you convert. If you expect to be in a lower tax bracket in the future when you withdraw the funds, then it might not make sense to convert now.
If you are under age 59½, and you use your traditional IRA funds to pay for the taxes when you do convert, you will incur a 10% penalty. Notably, a conversion itself is not a withdrawal, so there are no withdrawal penalties associated with a conversion.
How Much is the Early Withdrawal Penalty?
The early withdrawal penalty for a traditional or Roth individual retirement account (IRA) is 10% of the amount withdrawn. Also, you may owe income tax in addition to the penalty. You can withdraw contributions (but not earnings) early from a Roth IRA without being subject to income tax and the penalty.
When Can I Withdraw From an IRA?
In general, you can withdraw from either type of IRA penalty free when you’re age 59½ or older. To withdraw earnings from a Roth IRA without owing taxes or penalties, the account also has to be at least five years old. This is known as the five-year rule.
What are the Contribution Limits for IRAs?
In 2022, the annual contribution limit for traditional and Roth IRAs is $6,000. If you are 50 years and older, you can contribute an additional $1,000.
The Bottom Line
If you have a Roth IRA, you can take out your contributions (but not earnings) at any time without paying taxes and penalties. Otherwise, if you remove money early from either a traditional or Roth IRA, you can expect to pay a 10% penalty plus taxes on the income (unless you qualify for an exception).
Of course, the decision to take an early withdrawal should never be taken lightly. You could miss out on years of potential growth and earnings, which could have a detrimental effect on your nest egg.
It’s rarely advisable to raid retirement accounts. But if you must access your funds before retirement, then many of the best brokers for IRAs have further information on how to avoid these penalties.