Individual Retirement Accounts fall into two main categories: traditional and Roth accounts. While both are intended to hold funds set aside for retirement, people can make early withdrawals that are often subject to penalties. The two account types differ in terms of the tax status of invested funds. Roth funds are funded with post income tax earnings, while Traditional IRAs are funded with net earnings.
Premature Withdrawals
The Internal Revenue Service uses age 59 1/2 as the official retirement age for taxation purposes. Funds withdrawn from IRAs prior to the account holder reaching that age are classed as premature withdrawals and are subject to a 10 percent penalty fee. The IRS also imposes a seasoning requirement on IRA accounts, which means that account owners must pay the 10 percent penalty if they access funds that have been invested in IRAs for less than five years. Funds taken prematurely from Traditional IRA accounts are also subject to ordinary income tax, whereas only earnings and not the principal from a Roth are taxed.
Exceptions
The IRS allows people to withdraw up to $10,000 form IRAs without incurring the 10 percent penalty for premature withdrawals if the withdrawals are used to pay for qualified expenses. These qualified expenses include a home purchase within 120 days of the withdrawal and to cover otherwise non-reimbursed medical costs that exceed 7 1/2 percent of the account owners income. People can also make qualified withdrawals to pay for higher education expenses for themselves and certain family members.
60-Day Rule
The IRS enables people to withdraw money from an IRA an reinvest it into another tax-qualified account within 60 days. Many people use this provision to cover short-term expenses and then use other funds to replenish the IRA within the allotted time frame. The IRS requires IRA custodians to withhold 20 percent when withdrawals are made from Traditional IRAs, but this money gets credited back at tax time. No withholdings are made from Roth disbursements.
Required Minimum Distribution
The IRS compels people to start making withdrawals from Traditional IRA accounts when they turn age 70 1/2. Each year the IRS sets out guidelines that detail the formula for calculating these required-minimum-distributions. People must pay a 50 percent penalty on the amount of the RMD if they do not take it. Withdrawals are subject to regular income tax. The IRS does not require Roth IRA owners to begin making withdrawals because funds in Roth IRAs were taxed prior to investment.
