Taxes on individual retirement account redemptions or withdrawals depend on the type of IRA account, age of the redeemer and reason for the redemption. IRAs are vehicles for retirement saving and may be tax-deductible or tax-free depending on the type of IRA and the taxpayer's adjusted gross income or other retirement plan options.
Roth IRA contributions are made with after-tax dollars and are not deductible on federal income tax returns. However, earnings are not taxed if they are withdrawn after the Roth IRA owner turns 59 1/2, and unlike traditional IRAs, there is no age for mandatory withdrawal. Contributions may also be made past the age of 70 1/2, unlike traditional IRAs, as long as the account holder has earned income and meets the income eligibility requirements for Roth IRAs. A Roth IRA holder can withdraw the money he has contributed at any time tax free.
Traditional IRA contributions are made with pretax dollars, and withdrawals are subject to income tax. The assumption is that most traditional IRA contributors will be in a lower tax bracket after retirement, and withdrawals are taxed at that rate. Traditional IRA contributions are also deductible on federal income tax returns if the contributor meets the income limitations or is not covered by an employer-sponsored retirement plan. Those holding traditional IRAs may start redeeming funds upon reaching the age of 59 1/2, and must begin taking withdrawals upon reaching age 70 1/2.
Early Withdrawal Penalties
Because IRAs are meant for retirement purposes, early withdrawal penalties are steep. In addition to regular income taxes imposed on the withdrawn amount from traditional IRAs, early withdrawals for both Roth and traditional IRAs are subject to an additional 10-percent penalty. Early withdrawals are those taken before the IRA owner turns 59 1/2 that are not otherwise exempt from early withdrawal rules. The 10-percent extra tax applies to the amount of the early IRA distribution included in gross income for tax purposes.
Withdrawals may be made for certain purposes without incurring the 10-percent penalty, but the account holder still will incur ordinary income taxes on the amount withdrawn. These exceptions include paying for medical expenses above 7.5 percent of your adjusted gross income; legal disability; higher-education expenses for the taxpayer, spouse, children or step-children; and the purchase of a first home.