How Much Is the Tax on Early Retirement Withdrawal?

by Herb Kirchhoff

If you withdraw funds before age 59 1/2 from a traditional individual retirement arrangement (IRA), a Roth IRA or a 401k retirement plan, you may have to pay income taxes and possibly a 10-percent penalty tax on your "early" withdrawal. But the actual tax consequences of withdrawals before retirement age will depend on which of these most-popular retirement accounts you have.

Traditional IRA

A traditional IRA allows you to build up your retirement savings by deferring income taxes on your contributions and earnings until after retirement. You also get a tax deduction on up to $5,000 in yearly contributions -- $6,000 if you are older than 50. If you withdraw funds before age 59 1/2, you must pay income taxes on the withdrawn amount plus a 10-percent penalty tax. The income tax amount will depend on your tax bracket. You may avoid the penalty tax for a hardship withdrawal to pay medical expenses exceeding 7.5 percent of your income, pay health insurance premiums after losing your job, pay for college tuition or because you became disabled. You also can withdraw up to $10,000 without penalty to use as a down payment on your first home.

Roth IRA

A Roth IRA allows you to build up a tax-free income source at retirement. You get no tax deduction for Roth contributions, but earnings accumulate free of taxes. At retirement you can withdraw the funds without paying any taxes. If you withdraw from a Roth account before age 59 1/2, taxation will depend on how much you take out. You can withdraw the money you directly contributed without paying taxes or penalties.

Ordering Rule

Roth distributions are charged first to direct contributions, then to contributions from IRA rollovers and lastly to earnings. If your early distribution includes funds from an IRA rollover less than 5 years old or funds from earnings, you must pay income tax and the 10 percent early withdrawal penalty tax on the rollover/earnings amount. Regardless of your age, if you withdraw rollovers or earnings from a Roth account less than five years old, you will owe tax and a penalty on those funds. You can avoid the penalty tax on earnings if they are part of a hardship withdrawal, as defined for traditional IRAs.

401k Distributions

A 401k is a tax-deferred, employer-sponsored retirement plan that allows both you and your employer to contribute to your retirement fund. You get a tax deduction of up to $16,500 a year for the 401k contributions you make from your wages. Distributions before age 59 1/2 are subject to income taxes and the 10-percent penalty tax on early withdrawals. You can avoid the penalty tax if your distribution is a hardship withdrawal to pay extraordinary medical expenses, because you became disabled or is made to an alternate payee under a divorce or separation decree. Most 401k plans permit loans against your account balance. Loan proceeds are not taxable so long as you keep up the payments. If you default on a 401k loan, the outstanding proceeds become subject to income tax and the 10-percent penalty tax.

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