How to Calculate Taxes & Penalty When Cashing IRA

by D. Laverne O'Neal

The Individual Retirement Account (IRA) allows earners to deduct yearly contributions from taxable income. Non-qualified withdrawals trigger taxes and/or penalties. With the Roth IRA, after five years, pre-retirement withdrawals of principal are tax-free, though taking out earnings is subject to taxes and/or penalties. Once you reach age 59.5, die or become permanently disabled, all distributions are tax- and penalty-free. Other exceptions can make the withdrawal taxable but not subject to penalty. For discussion purposes, assume the account holder is able-bodied, has not yet reached age 59.5 and that none of the exceptions apply.

1. Gather your income data for the tax year. This may include pay stubs, Form W-2, Form 1099 or other documents.

2. Work through the first page of IRS Form 1040 until you have calculated your modified adjusted gross income (AGI), typically about the final entry on the page. You might also work through an online tax form to discover your modified AGI.

3. Look up your income tax rate for the year on the IRS tax-rate schedule, published online and in print.

4. Convert the tax rate to a decimal. For example, if the rate is 15 percent, the decimal representation is 0.15.

5. Multiply the amount of the non-qualified distribution by the tax rate. For example, if you withdraw $5,000, multiply $5,000 by 0.15 to get $750.

6. Multiply the withdrawal amount by 10 percent, if it is subject to penalty. For example, $5,000 times 0.10 equals $500.

7. Add the results of the two calculations to find the total tax liability. In this example, $500 plus $750 equals $1,250. This leaves only $3,750 to the account holder, ample evidence that making non-qualified IRA distributions should be an act of last resort.