You will generally have to pay a tax penalty for withdrawing funds early from an Individual Retirement Account (IRA). However, you can transfer the money into another IRA without penalty if you follow the right process.
Learn more about taxation on early IRA withdrawals, the process of closing an IRA, and how to minimize the tax and other costs associated with it.
Key Takeaways
- Traditional IRAs have early withdrawal penalties prior to age 59½, with certain exceptions.
- Money withdrawn early from a traditional IRA also is taxable as ordinary income.
- The money you pay into a Roth IRA may be withdrawn early without paying a penalty or taxes if the account has been open for five years or more.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 out early without incurring a penalty and taxes.
Withdrawals, Tax Brackets, and Penalties
Traditional IRAs
Money withdrawn from a traditional IRA is taxed in the year in which it is withdrawn regardless of your age when you take money out.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.
Speak with a qualified tax professional to confirm your situation qualifies for an exception.
Roth IRAs
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.
Withdrawing Roth money early
You can take out the money you contribute at any time because you already paid the income taxes on that money. Taking out the earnings you made on your investments early, however, can have tax consequences.
If you withdraw money earned on investments 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.
Note
There are some exceptions to the rules for withdrawing IRA funds early. So should speak with a tax professional about your own situation.
Rolling Over an IRA
You can rollover money from an IRA to another retirement account without facing tax penalties, but you must meet certain deadlines. Typically, you will then pay any taxation when you withdraw the funds from the new acccount.
You can move money from one IRA to another without paying taxes if you rollover the funds within 60 days of receiving the distribution. In some cases, namely if you miss the deadline for reasons beyond your control, you may get an extension.
You can rollover funds from an IRA once per year without incurring taxation.
Inheriting 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.
If you take an early withdrawal, even for an allowable exception, you'll still owe income taxes on the 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.
Frequently Asked Questions (FAQs)
How Much Does it Cost to Close an IRA Account?
There is no account-related fee to closing an IRA account, but you may face a tax penalty if you withdraw funds from a tax-advantaged account early. You can roll over an IRA into another retirement account without penalty if you follow the process.
Can You Rollover an IRA to a 401(k)?
The IRS permits certain rollovers from one tax advantaged retirement account to another, but not moving funds from an IRA to a 401(k). It is more common to move funds from a 401(k) to an individual IRA.
Can I Rollover Funds from a Roth IRA to a Traditional IRA?
You cannot rollover funds from a Roth IRA to a traditional IRA, but you can do the reverse if you report the distributions as part of your taxable income. You can also rollover funds from a traditional IRA to another traditional IRA, or move funds from one Roth account to another.
The Bottom Line
You can close an IRA account and avoid tax penalties if you follow the correct process. Whether closing your IRA account is the right move will depend on your specific financial situation and goals. For guidance, consider consulting a financial advisor.
