Penalties associated with Early Withdrawal out of an Ira

An Individual Retirement Account (IRA) is a tax-friendly retirement savings plan. In a standard IRA, contributions are tax-deductible, but tax must be paid on all withdrawals. In a Roth IRA, designated Roth contributions are included in gross income. However, Roth IRA earnings are non-taxable.

Funds in an IRA must be kept in the plan for a minimum of 5 consecutive tax years. Qualified distributions can begin anytime after the employee is 59-1/2 years old, provided the 5 year seasoning period has passed. Although tax must be paid on distributions from standard IRAs, all qualified distributions from Roth IRAs are completely tax-free.

As long as the conditions of the IRA are met, withdrawals are not subject to penalties of any kind. However, early withdrawals are subject to an IRA penalty of 10%, and are also taxed normally in standard IRAs.

However, you can avoid this 10% penalty, even when making early withdrawals from your IRA. These special exceptions apply:

* A 1-time penalty-free IRA distribution is allowed when buying a first house, which is to be used as a principal residence. The lifetime maximum on this withdrawal is $10,000.

* Special penalty-free IRA distributions are allowed for the portion of unreimbursed medical expenses that are more than 7.5% of adjusted gross income.

* Special penalty-free distributions are allowed that are not more than the qualified higher education expenses of the IRA owner or his children or grandchildren.

An employee is also eligible for qualified distributions from an IRA if he becomes disabled. Qualified distributions may be made instead to an alternative payee or beneficiary, providing one of these conditions is met.

In case of employee death, qualified distributions may be made to the alternate payee or surviving spouse. The qualified distribution may also be rolled over to that person’s designated IRA. A surviving spouse who also holds a Roth IRA can combine the two Roth IRAs into a single plan without any tax penalty. Thus, in estate planning, it is almost always a good idea to keep money in a Roth IRA.

IRA penalties are not limited to early withdrawal. For standard IRAs, late withdrawal can prove even more expensive.

Required minimum distributions from non-Roth IRAs must begin by April 1 of the year after reaching 70-1/2 years old. Failure to begin taking the required minimum distribution at this point carries a penalty of half the amount that should have been taken. Roth IRAs are not subject to this restriction.