IRA Liquidation Penalties

Liquidating an IRA can provide emergency cash.

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Saving for retirement should be a financial concern for workers of all ages. An IRA, or individual retirement account, is a savings account with special protections and benefits that allows you to set money aside for retirement, regardless of whether your employer offers a retirement savings plan. Because an IRA provides tax benefits, liquidating one to receive cash can lead to penalties that may not make it worth cashing in.

Early Withdrawal

The minimum age for withdrawing money from an IRA without penalties is 59 1/2. This age limit applies whether you plan to liquidate the entire IRA or withdraw only a portion of the funds in the account. Once you reach age 59 1/2, you can liquidate your IRA with much more financial flexibility, but if you're younger, you will need to take steps to avoid or plan for penalties.

Cost of the Penalty

If you liquidate an IRA before reaching age 59 1/2 and don't qualify for an exception, you will need to report the money you receive as income on your tax return. The IRA income from the early withdrawal is taxed as income, but is also treated differently from other income: An additional 10-percent tax penalty will apply to the money you receive, regardless of the amount. This is different from the tax on most other income, which changes based on how much you make.

Alternatives

Instead of enduring an IRA liquidation penalty, you can pursue other ways of getting emergency cash. The amount you need and the length of time you will need it will determine the best source. Taking money out of a regular savings account will have less of an impact than an early IRA withdrawal. For short-term needs, a cash advance from a credit card may be a better option, if you can pay the money back before incurring large finance charges. A bank loan or second mortgage may be another option, depending on the reason you need the money.

Avoiding Penalties

If you qualify for an exception you may be able to liquidate an IRA early without paying a penalty. This is only an option if you plan to use the money you receive for one of several specific purposes. Early IRA distributions that pay for college tuition for yourself, your spouse, your child, or a grandchild are free from penalties. The same is true for up to $10,000 that you receive from an IRA to purchase your first home. Some medical and disability expenses are also eligible for penalty-free IRA withdrawals before age 59 1/2.

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