Does an Early IRA Withdrawal Affect or Count for Income Tax Purposes?

by Michael Keenan

Even though the Internal Revenue Service (IRS) intends that you use individual retirement accounts (IRAs) for retirement savings, no law prohibits you from taking an early distribution, meaning a distribution before age 59 1/2. However, you may have to pay extra taxes and an additional income tax penalty when you take an early IRA distribution.

Traditional Early IRA Distributions

If you take an early distribution from a traditional IRA, you have to pay income taxes on the entire amount unless you made some nondeductible contributions. Nondeductible contributions occur when you intentionally do not deduct the contribution on your income taxes either because you have an employer plan and your modified adjusted gross income is too high or you elect to make a nondeductible contribution. In the event you do have nondeductible contributions, your early withdrawal will be apportioned based on the percentage of nondeductible contributions in your account. For example, if your traditional IRA has 13 percent nondeductible contributions in it at the time of your early withdrawal, 13 percent of your distribution is tax-free, 87 percent is taxable.

Roth IRA Early Distributions

Roth IRAs calculate your taxable and non-taxable portions of your early withdrawal differently. Since all contributions to a Roth IRA are after-tax, you can remove all your contributions. Unlike a traditional IRA, you remove all the contributions first. Only then do you remove earnings, but if you do withdraw earnings, they are taxable and subject to the early withdrawal penalty. For example, if you have $20,000 of contributions in your Roth IRA and you take an early distribution of $23,000, $3,000 is taxable.

Early Withdrawal Tax Penalty

When you take an early withdrawal from your IRA, the taxable portion is subject to a 10 percent income tax penalty. For example, a $5,000 early withdrawal would typically result in a $500 tax penalty. This penalty increases your income tax liability rather than replacing your income taxes on the early distribution. However, some exceptions to the penalty, such as medical premiums while uninsured or college expenses, allow you to take an early distribution without paying the early withdrawal penalty.

Tax Reporting Considerations

All early IRA distributions, including completely tax-free distributions from Roth IRAs, must be reported on your income taxes. Early Roth IRA withdrawals and withdrawals from a traditional IRA with nondeductible contributions require completing Form 8606. For any withdrawals containing a taxable portion, you must also complete Form 5329. When you file your income taxes, you have to use Form 1040 if you owe an early withdrawal penalty. If not, you can use Form 1040A.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."