Reimbursement of Early Withdrawal From an IRA

by Angie Mohr

Individual retirement accounts (IRAs) are tax-advantaged investment accounts that allow individuals to defer part of their current income and save it for retirement. If a plan owner takes money out of an IRA before retirement age, there are often penalties and tax implications. These depend on the person's financial situation and the type of IRA.

Traditional IRAs vs. Roth IRAs

The taxes and penalties you must pay on an early IRA withdrawal are partly dependent on the type of IRA you have. Contributions to traditional IRAs give you a tax deduction going in, so they are taxable income when they come out. Roth IRAs are contributed after-tax and you can withdraw up to your contribution limit tax-free and without penalty. If you withdraw any of the income portion early, you will pay both tax and penalties in most situations.

Penalties

If you withdraw taxable IRA funds from your plan before you turn 59-1/2, you will be subject to a 10-percent penalty on the total amount of the taxable withdrawal. This penalty is calculated on your income tax return at the end of the year. The IRA administrator will likely also withhold at least 10 percent of your taxable withdrawal as tax withholding. You will get credit for this tax paid on your tax return.

Hardship Withdrawals

If you are withdrawing early from your plan because you are experiencing financial hardship, you may not have to pay the 10-percent penalty. Recognized hardships include large medical expenses, disability and a down payment on a first home. Each plan has different requirements for establishing a hardship case, so read your plan documents thoroughly to see if you qualify. If you are allowed a hardship withdrawal, you will still have to pay tax on any taxable portion.

60-Day Rule

If you plan on putting withdrawn money back into your IRA, there are strict time limits to do so. If you put the money back into the same or a new IRA plan within 60 days of the withdrawal, there will be no penalties or tax consequences. You can reimburse as much of the withdrawal as you wish, but, if the total withdrawals exceed the reimbursement, you will be taxed and penalized on the difference. If you miss the 60-day window, you are restricted in what you can put into your IRA. You can only contribute a maximum of $5,000 annually in an IRA, or $6,000 if you're 50 or over, up to a maximum of 100 percent of your earned income. The 60-day rule allows you to "borrow" from your IRA for short periods of time if necessary, but the consequences of missing the reimbursement window are steep.

About the Author

Angie Mohr is a syndicated finance columnist who has been writing professionally since 1987. She is the author of the bestselling "Numbers 101 for Small Business" books and "Piggy Banks to Paychecks: Helping Kids Understand the Value of a Dollar." She is a chartered accountant, certified management accountant and certified public accountant with a Bachelor of Arts in economics from Wilfrid Laurier University.

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