One of the key pieces to retirement planning is understanding when and how much you can withdraw from your account.
Your individual retirement account comes with rules about when you can withdraw money and how much you must withdraw each year. Understanding IRA withdrawal rules is vital if you want to avoid paying penalties.
Why Are There IRA Withdrawal Rules?
It’s your money, so why are there rules about withdrawing from an IRA?
The government offers you a tax benefit when you invest using an IRA. As a result, the government expects you to use this tax-advantaged money for its intended purpose — retirement — and sets rules accordingly.
When you break the IRA withdrawal rules, you are subject to a penalty. This penalty can be hefty, depending on the circumstances. Additionally, the penalty depends on the type of IRA you have. There are slightly different rules for traditional and Roth IRA accounts. (You can learn about the differences between traditional and Roth IRAs here.)
Before you take money out of your IRA, make sure you understand what’s expected of you.
Traditional IRA Withdrawal Rules
The rules for withdrawing from a traditional IRA are more stringent than those for a Roth IRA. When you contribute to a traditional IRA, the money is pre-tax, meaning you get a tax deduction for your contributions. (Here’s a quick guide to common tax deductions.)
As a result — except for specific circumstances — the IRS expects you to keep your money in the account for a long period of time.
Withdrawing From an IRA Before Age 59½
If you take money out of your traditional IRA before you reach age 59½, you are subject to a 10% penalty. That penalty is on top of the federal and state income taxes you owe on the withdrawal.
There are exceptions to this rule. You can avoid the penalty if you withdraw the money for the following reasons:
- Buying a home for the first time
- Qualified education expenses
- Health insurance (if you are unemployed)
- Medical expenses that weren’t reimbursed
If you go this route, talk to a tax professional and use IRS Form 5329 to ensure you aren’t penalized.
Regular Retirement Withdrawals
During your “regular” retirement years, which start at age 59½, you can take money from your retirement account to cover any expenses you have. Though you won’t face penalties, you will be taxed at your marginal rate for withdrawals since they are considered part of your income.
Withdrawing From an IRA at Age 70½
Once you reach age 70½, you must take withdrawals from your traditional IRA. Up until this age, you aren’t required to take money out of your IRA if you don’t want to. However, at age 70½, you must take the required minimum distribution (RMD).
Your RMDs are based on a formula that takes into account the amount in your IRA and your life expectancy. If you don’t take the required amount, you will face a penalty of 50% of the amount you should have withdrawn.
Consult with a financial professional to help you figure out the best way to withdraw money from your IRA between age 59½ and 70½ to reduce the pain caused by RMD. A financial professional can help you create a plan that also takes into account the impact of Social Security benefits. Coordinate your benefits and plan withdrawals for best results.
Roth IRA Withdrawal Rules
Roth IRA withdrawal rules are a little different. Because you contribute after-tax dollars to this account, reaping no immediate benefit, some of the rules are more flexible. However, you still need to be aware of potential pitfalls and penalties.
Withdrawing From Your Roth IRA
With this type of account, it’s important to make the distinction between your contributions and your earnings.
Say you invest $5,000 in your Roth IRA each year for two years. During that time, your account grows to $16,000. In this case, your contributions total $10,000 and your earnings come to $6,000.
You can withdraw your original contributions anytime without tax or penalty. This is the money you put in after-tax, and you can use it to pay for anything.
Once you start dipping into your earnings, however, you’ll face extra charges. Tap into the earnings from your Roth IRA before you reach age 59½ and you’ll pay a 10% penalty. Plus, an early withdrawal could be subject to tax — something you normally don’t pay on Roth IRA earnings if you withdraw after age 59½.
One nice bonus of a Roth IRA? There are no RMDs associated with this account type. It doesn’t matter how old you are — you will never be forced to take money out of your Roth.
The Five-Year Rule
You need to be aware of the five-year rule with your Roth IRA. This regulation states that initial contributions to your Roth IRA must be made at least five years before you start withdrawing earnings.
Say you’re 57 when you start contributing to a Roth IRA. In that case, you can’t actually start withdrawing your earnings at age 59½ without triggering a penalty — since the five years hasn’t been met. You need to wait until you are at least 62 to satisfy the rule.
In the end, IRA withdrawal rules are fairly straightforward. If you have questions, consult a tax professional before you take money from your IRA. That way, you have a plan in place.
Image: Tom Merton