With jobs in short supply, many people are looking to their IRA balances as a ready source of emergency cash -- either to fund a business venture or simply to pay living expenses. The individual retirement arrangement was never designed to be a short-term savings program, however, and the IRS has put significant penalties in place to discourage investors from tapping their IRAs prior to retirement.
Income Taxes for Traditional IRAs
For traditional IRAs, you can expect to pay income taxes on withdrawals you make from IRA accounts in most instances. The IRS will charge income tax on the difference between the money you withdraw attributable to growth and the money you withdraw attributable to your tax basis. If your contributions were all tax deductible, your tax basis is zero. However, if you made nondeductible contributions, you will not be taxed on the return of your own capital.
Income Taxes on Roth IRAs
Because you already paid income tax on Roth IRA contributions, there is no income tax due on Roth IRA assets withdrawn, provided those assets have been in the Roth IRA account at least five years. If the assets have not been in the IRA account at least five years, you will have an income tax bill.
10 Percent Penalty
You will also pay a 10 percent penalty on amounts withdrawn from traditional IRAs, and on any growth withdrawn from Roth IRAs, unless certain hardship exemptions apply. These include death, disability, avoiding foreclosure, avoiding being evicted, paying college expenses, paying medical expenses in excess of 7.5 percent of your income, paying a down payment of up to $10,000 on a home or taking a series of equal or substantially equal payments, spread out over your remaining life expectancy in a 72(t) transaction.
Provision for Liquidation of IRA accounts
Generally, IRA accounts fall under income tax rules, rather than capital gains tax rules. However, the IRS makes an exception if you liquidate an entire IRA account. If you liquidate, you will pay capital gains taxes, which may be more favorable than income taxes if you have a substantial portion of the securities in your IRA for longer than a year. If you liquidate your IRA account at a loss, then you can use those capital losses to cancel out capital gains elsewhere in your portfolio. However, you must liquidate all your Roth accounts, or all your traditional accounts, and you must have non-deductible contributions in traditional accounts in order to claim the losses. You must also itemize your deductions, and claim the loss on Schedule A, rather than Schedule D. This means that the loss deduction is subject to the 2 percent of AGI floor that applies to other itemized deductions. Unless you have other itemized deductions that add up to two percent of your income, this may disallow some or all of your deductions for the loss.
Your broker may charge a fee or commission for any transactions you make within your IRA, including cashing out the IRA. For details, consult the terms and conditions of your contract with your broker. Some mutual funds also charge liquidation fees of up to 2 percent on account balances withdrawn within a certain amount of time of contributing.