The economic downturn of the past few years has caused many people in California and across the country to tighten their belts and watch their budgets carefully. For some people, wages and savings were not enough to cover costs and they unfortunately had to withdraw money from retirement accounts. Under certain conditions, taking funds out of an IRA account can have tax consequences.
In general, the IRS penalizes withdrawals that occur before a taxpayer reaches a certain age. The IRS calls these early withdrawals “premature distributions.” A distribution is premature if you receive it before you reach the age of 59 years and six months. All taxpayers receiving premature distributions must report them to the IRS, which in most cases will subject the funds to a 10 percent tax over and above any taxes normally paid on distributions from retirement accounts.
The 10 percent tax is a general rule that has many exceptions, however. For example, taxpayers can avoid the tax if the distribution is used for certain expenses, such as qualifying costs for education or medical treatment. In addition, those who have a permanent and total disability are not subject to the 10 percent additional tax.
The tax also does not apply in other situations. A taxpayer who receives a distribution from an IRA but rolls the funds over to another IRA within 60 days will not have to pay the 10 percent tax. Taxpayers who are not allowed to deduct certain contributions to their IRAs will have the amount of those nondeductible contributions exempt from the 10 percent tax if they receive an early distribution. But if the retirement plan is a Roth IRA, any taxpayer contributions are not taxed if withdrawn early.
Source: Internal Revenue Service, “Early Distribution from Retirement Plans May Have a Tax Impact,” IRS Tax Tip 2012-34, Feb. 21, 2012.