Traditional individual retirement accounts are pre-tax vehicles, meaning the money you put into them has never been taxed. If you close your IRA, you're generally liable for income tax on the entire balance, and may owe additional penalties. Roth IRAs generally allow for tax-free withdrawals, although certain distributions will still trigger a tax liability. In both cases, you'll have to report the closure of your account when you file your taxes.
In addition to your tax-deductible contributions, all the earnings in your traditional IRA are fully taxable upon distribution. If you close your IRA, you don't have to pay the tax immediately. At year-end, you'll receive a 1099-R from your IRA custodian showing the amount of your withdrawal. This amount will also be reported to the IRS, but you are still responsible for including it on your own taxes. The IRS treats IRA distributions as ordinary income, the same as the money you earn from your job, and will be taxed accordingly at the time you file your income tax return.
A Roth IRA is a special type of retirement account that carries different tax benefits. You don't get a tax deduction on your Roth contributions, but instead you can usually take tax-free withdrawals. Assuming your money has been in your Roth at least five years and you are over age 59 1/2, closing your Roth account would trigger no tax consequences. Otherwise, you'd owe tax on the earnings you withdraw from the account, calculated as the total value distributed less the amount you put in.
If you close an IRA, you can roll over that money to another IRA, or to a tax advantaged account such as a 401(k), within 60 days and suffer no tax consequences. In this scenario, closing your IRA results in no tax liability at all. You can also take advantage of the tax-free rollover provision to take a short-term loan from an IRA, as long as you redeposit the money within 60 days and don't roll that money more than once per year.
In addition to income tax, you may face penalty taxes after you close your IRA. The IRS applies a 10 percent penalty to IRA withdrawals taken before the owner is age 59 1/2. In a Roth IRA, only your earnings are subject to this early distribution penalty. Any contributions you make to a Roth IRA can be taken out again penalty-free at any time. With a traditional IRA, the penalty applies to your entire balance. You'll pay the penalty tax at the same time you file your return.
John Csiszar has written thousands of articles on financial services based on his extensive experience in the industry. Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to his online work, he has published five educational books for young adults.