What Happens When You Withdraw Money From a Traditional IRA?

If you are saving for retirement with a traditional tax-deferred individual retirement arrangement or IRA, you must eventually withdraw money from your account. The Internal Revenue Service has tax rules covering different IRA withdrawal situations. What happens tax-wise when you take a distribution of money from your traditional IRA will depend on the circumstances that led you to take money out of the account.

Retirement Income

When you reach 59.5 years of age, you can start taking retirement distributions from your traditional IRA without restrictions or penalties. But you will owe federal income tax on the money you take out, and may owe state income taxes as well. You report retirement distributions on your tax return. They are taxed as ordinary income at the same rate applied to all your other taxable income. IRA retirement withdrawals are not taxed at the lower capital gains rate even though the IRA includes earnings and capital gains from investments. Congress taxes IRA withdrawals at retirement in return for giving you a tax deduction for your IRA contributions during your working years.

Early Distributions

If you take a distribution out of your traditional IRA before you reach 59.5 years, it is called an early distribution. You will owe not only the income tax on the money, but you also will be assessed a federal penalty tax equal to 10 percent of the money you withdrew. If you were in the 25 percent tax bracket and took an early distribution of $1,000, you would pay $250 in income tax and $100 for the early withdrawal penalty. You would net only $650 after 35 percent of your early distribution is taken for taxes and penalties.

Penalty Exceptions

There are certain circumstances where the IRS will waive the 10 percent penalty tax, although you will still owe income tax. The penalty will be waived if you take an early distribution because of permanent disability, to pay college tuition, to pay health insurance premiums if you’ve been unemployed at least 12 weeks, to pay unreimbursed medical expenses exceeding 7.5 percent of gross income, or to pay your heirs after your death. You also avoid the penalty if you withdraw up to $10,000 to buy or build your first house, take out money to satisfy an IRS tax levy, or to pay family living expenses if you are a National Guard reservist called to active duty for at least six months. You can also avoid the penalty if you take your distribution in a series of equal payments over multiple years rather than a lump sum.

Mandatory Withdrawals

When you reach 70.5 years of age, you must start taking minimum withdrawals. You must take your first withdrawal by April 1 of the year following the year you turned 70.5 years. You figure your required minimum each year by dividing your account balance by your years of remaining life expectancy, as defined in IRS longevity tables. The minimum must be recalculated each year because your account balance will be less while you have grown a year older. If you fail to take your required minimum distribution each year, you will be assessed a penalty tax equal to 50 percent of the amount you were supposed to withdraw.

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