An individual retirement account (IRA) is a personal saving plan that allows you to prepare for your financial future. Since an IRA is a tax-shelter, cashing in early may result in surrender fees and penalties. Unfortunately, IRS surrender fees do not qualify as tax deductions. Depending on the type of IRA you have, withdrawals may be allowed without having to face fees.
An IRA offers tax advantages when saving for retirement. In 1974, IRAs were introduced allowing employees to contribute a portion of their earnings towards retirement, while also reducing their taxable income. Anything you withdraw from your IRA is considered income that must be reported when you file taxes. However, distributions from an IRA are not considered earned income, which means you do not pay Federal Insurance Contributions Act (FICA) taxes. There are different types of IRA accounts.
The most basic type of IRA is known as a traditional IRA. Contributions made to your traditional IRA are tax deductible. Withdrawals from the account, however, are taxed at the tax rate based on your income bracket. The surrender charge will not be included in the taxable portion of the IRA withdrawal. Since you are required to pay taxes on the distribution, anything you withdraw from the IRA reduces the taxable value of the IRA.
A Roth IRA is a retirement account that is generally not taxed. Unlike a traditional IRA, which offers a tax break on the funds inside the account, a Roth IRA provides a tax break on the money you withdraw from the account during your retirement. As a Roth IRA account holder, you are allowed qualified withdrawals without penalties if the account is open for minimum of five years and you are at least 59 and a half years of age. If you choose to take an early distribution of earnings, the amount must be included taxable income and results in a 10-percent penalty.
You may also purchase an annuity inside of a Roth IRA. This type of retirement account combines the benefits of an annuity with benefits of a Roth IRA account. Although the combination allows tax-free distribution during retirement, surrender charges typically apply to most annuities. If you withdraw prior to reaching age 59 and a half, account earnings may be subject to a 10 percent IRS penalty. Your contract can also include withdrawal and surrender fees in addition to IRS fees. For example, an 8 percent fee may be charged for withdrawals during the first three years, declining by 1 percent each year after. Surrender charges are not tax deductible.
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