The Internal Revenue Service's rules for individual retirement accounts permit you to close an IRA at any time, even if you have no pressing financial need. However, when you close your IRA you must pay any applicable income taxes and penalties, and you suffer a permanent decrease in your IRA value.
Closing your IRA by taking a qualified distribution is less costly than closing it with a nonqualified distribution. For traditional IRAs, once you turn 59 1/2, you can close your traditional IRA with a qualified distribution. For Roth IRAs, you must be 59 1/2, and your Roth IRA must be 5 years old, to close it with a qualified distribution. Any distribution from your IRA that does not meet the requirements to be a qualified distribution counts as a nonqualified distribution. When you close your IRA by taking a qualified distribution you do not incur any penalties, but you still have to pay taxes on distributions from a traditional IRA. If you close your Roth IRA with a qualified distribution, you do not pay any taxes.
Nonqualified Distribution Penalties
When you close your IRA by taking a nonqualified distribution, the taxable portion of your proceeds from closing the account are subject to a 10 percent penalty. This penalty is on top of the income taxes you owe for closing your IRA. In limited circumstances you can avoid the penalty; for instance, if you close your account to pay for medical expenses that exceed 7.5 percent of your adjusted gross income, or to pay for college costs.
When you close your IRA, you cripple your retirement savings because you cannot put the money back in later on. For example, if you take out $50,000 when you close your IRA and your annual contribution limit is $5,000, it would take you 10 years to replace the money taken from the account. In addition, the money you take out no longer grows tax-sheltered. This means that any future earnings on the money are taxable in the year you receive them.
If you close your IRA by taking a qualified distribution, you simply report the amount of the distribution as either a taxable or nontaxable IRA distribution -- depending on the type of IRA you chose -- on Form 1040A or Form 1040. If you take a nonqualified distribution, use Form 8606 to calculate the taxable portion of your proceeds from closing the account, Form 5329 to calculate your early-withdrawal penalty, and Form 1040 to report the taxable portion, nontaxable portion and your nonqualified withdrawal penalty.
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