Dissolving an IRA for Taxes

by Mark Kennan

You can dissolve your IRA at any time and for any reason. However, because IRAs were intended to help save for retirement, you may experience some expensive tax consequences if you dissolve your IRA before you are old enough take qualified distributions. For example, the taxable portion of both traditional and Roth IRA dissolutions gets hit with an extra 10-percent penalty, and Roth IRA earnings, which come out tax-free in qualified distributions, become taxable income. When you dissolve your IRA, you have to correctly report it on your income tax return to avoid further tax penalties.

Request a distribution for the entire value of the IRA. Your financial institution cannot stop you from dissolving your IRA at any time, no matter what your reason.

Complete Form 8606 if you are dissolving a nonqualified Roth IRA or a traditional IRA containing any nondeductible contributions. A nonqualified Roth IRA refers to a Roth IRA that has either not been open for five tax years or if you are under age 59-1/2. This form calculates how much, if any, of your liquidation is taxable.

Fill out Form 5329 if you are taking a nonqualified distribution and any of the distribution counts as taxable income. This form calculates the early withdrawal penalty the IRS imposes for withdrawing money before reaching age 59-1/2. However, you can avoid some or all of this penalty if you qualify for an exemption, which is also reported on Form 5329.

Report the nontaxable amount of your IRA dissolution on line 15a and the taxable amount on line 15b of Form 1040. Also on Form 1040, enter your early withdrawal penalty on line 58 and your income taxes withheld from your IRA dissolution on line 61.

Items you will need

  • IRS Form 8606
  • IRS Form 5329
  • IRS Form 1040

Photo Credits

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