3 Reasons Not to Take Money Out of an IRA Early

3 Reasons Not to Take Money Out of an IRA Early
3 Reasons Not to Take Money Out of an IRA Early

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Fact checked by Vikki VelasquezReviewed by David KindnessFact checked by Vikki VelasquezReviewed by David Kindness

Yes, you can withdraw money from your individual retirement account (IRA) while you’re still working. However, you may not want to—for three main reasons.

Key Takeaways

  • Early withdrawals from a traditional IRA generally trigger a 10% penalty from the IRS.
  • All withdrawals from a traditional IRA are taxable income.
  • Money you remove from an IRA is money that will no longer be earning you a return during your pre-retirement years.

1. You’ll Pay a Penalty

The first is the tax penalty imposed by the Internal Revenue Service (IRS). If you take money out of a traditional IRA before age 59½, you’ll usually pay a 10% federal tax penalty and may also possibly face state tax penalties.

Early withdrawals without penalty are allowed only in the following situations:

  • Up to $10,000 for a “first time” home purchase (meaning you haven’t owned a home in the last two years)
  • For qualified education expenses (tuition, fees, room and board, textbooks, and other required expenses for yourself, your kids, your spouse, or your grandkids at any school that has been approved under the federal student aid program)
  • If you become permanently and totally disabled
  • To pay for unreimbursed medical expenses exceeding 7.5% of your adjusted gross income
  • To pay for health insurance premiums while you’re unemployed for 12 weeks or more
  • If you take substantially equal periodic payments, meaning you take the distributions on a regular schedule in amounts based on your life expectancy

If you have a Roth IRA, you can take out your contributions at any time without penalty, as you’ve already paid tax on the contributions.

However, you cannot remove any of the earnings without paying a penalty before age 59½. The exceptions: If you become disabled or if you make a qualified first-time home purchase (for which you can only withdraw up to $10,000).

There is also a five-year requirement, meaning that if you want to withdraw earnings tax-free and penalty-free for one of these two approved early withdrawal purposes, your Roth account must be in existence for at least five years.

2. You’ll Owe Taxes

The second is taxes. You pay taxes on the amount withdrawn from a traditional IRA regardless of your age because your contributions were made in pre-tax dollars.

Your tax rate while you’re working might be higher than your tax rate in retirement, so it can cost you more in taxes to take a traditional IRA distribution while you’re still working.

3. Harm to Your Long-Term Financial Plan

The third is the harm you might cause to your long-term financial plan. Any money you withdraw early is not just money you won’t have later; it’s money on which you will not earn years of compound returns you could have racked up. The loss can end up being quite substantial.

Advisor Insight

Alina Parizianu, CFP®, MBA
MMBB Financial Services, Great Neck, NY

The fact that you are working doesn’t impact your eligibility to take a distribution, but there may be certain taxes and penalties. For a traditional IRA, you have to pay income tax on the withdrawal. If you are under age 59½, you will also pay a 10% penalty, subject to some exceptions. If the account is a Roth IRA, the distribution is made after five years from the first contribution, and the owner is 59½ years old, the distribution is tax- and penalty-free. If, however, one of the above conditions is not met, distributions are subject to the following:

  • Contributions: always tax- and penalty-free.
  • Conversions: tax-free but subject to 10% penalty if less than five years.
  • Earnings: taxes and a 10% penalty apply.

Distributions must be taken in the following order: contributions, conversions, and earnings.

Read the original article on Investopedia.

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