An individual retirement account can consist of several types of investments, such as mutual funds, stocks or real estate. You can also create an IRA money market account or certificate of deposit. In most cases, you need to keep money in an IRA until you reach the age of 59 1/2 or you will face an early withdrawal penalty. However, you can move money inside an IRA from one account to another.
Early Withdrawal Penalties
When you remove money from an IRA and place it in a regular money market account, you will need to pay a 10-percent penalty tax on the amount you withdraw, in addition to income tax on the amount of the withdrawal. For example, if you withdraw $5,000, you will owe a tax of $500. The penalty only applies if you have not reached age 59 1/2. There are also some exceptions to the early distribution rule. For example, if you become disabled and transfer your IRA to a money market, you will not owe the penalty tax. You must be able to prove that you are permanently disabled to avoid the penalty, though. You can also avoid the 10-percent penalty if you are the beneficiary of an IRA and the original owner has passed away.
When you make contributions to a traditional IRA, you are generally able to deduct the amount from your income, so that it is initially tax-free. You will owe income tax on the original amount plus earnings if you withdraw it from that type of account, including if you withdraw it and place the money in a standard money market account.
Rolling over money from one qualified account to another -- for example, from a 401(k) into an IRA -- carries no tax consequences, regardless of your investment choices. But if you roll money from an IRA into a non-qualified account, like a simple money market fund, you will likely owe a 10-percent penalty plus income taxes on the amount of the rollover unless you are 59 1/2 or older.
Lower Returns in Money Market
While not a direct penalty, another consequence of moving funds from a stock or bond mutual fund into a money market fund -- even if it is still within an IRA account -- is that a money market typically has a lower rate of return. At the time of publication, the interest rate for money market funds was less than 1 percent, even for money market investments of more than $100,000. Other investment options have an average rate of return around 8 percent per year.
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