IRA Distribution Taxation

Taking an IRA distribution too soon can cost you on your taxes.

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Whether you've been stashing money for retirement since your 20s or you only recently started putting money away, seeing the account balance of your individual retirement account can make you think of all the things you could spend that money on. The taxes and penalties on your IRA distributions depends largely on the type of the IRA and the timing of the distribution.

Ordinary Income

All IRA distributions count as ordinary income and are taxed at your ordinary income tax rates for the year. It does not matter how you invested the money while in the IRA. Even if you had the entire amount invested in stocks that you held for over a year, and therefore would have qualified for the lower capital gains rates if the money were held in a taxable account, you still must pay the ordinary income tax rates.

Traditional IRA Withdrawals

Unless you put in non-deductible contributions, your traditional IRA distributions are always taxable, even if you take qualified distributions. For traditional IRAs, a qualified distribution means that you are 59 1/2 years old or older when you take the money out. If you have put in non-deductible contributions, either because you didn't qualify to take the deduction or you elected to make non-deductible contributions, prorate your distribution between the non-deductible contributions and the remainder of the account. The non-deductible contributions portion comes out tax-free. Say, for example, 14 percent of your traditional IRA value comes from non-deductible contributions at the time of the distribution: You get 14 percent of the distribution tax-free.

Roth IRA Withdrawals

If you take a qualified Roth IRA withdrawal, all the money comes out tax-free. However, to do so you must satisfy two conditions. First, your Roth IRA must be open for at least five years, counting from Jan. 1 of the first tax year you made your contribution. Second, you must be either 59 1/2, permanently disabled or using $10,000 to buy a first home. If you cannot take a qualified distribution, you can still take your contributions out tax-free and penalty-free whenever you want. But, if you take out any earnings, you'll owe taxes and early withdrawal penalties.

Early Withdrawal Penalties

When you take an early, or non-qualified, withdrawal, the IRS tacks on a 10 percent tax penalty to the taxable portion of the distribution unless you qualify for an exception. For example, if you take a $3,000 taxable traditional IRA early withdrawal, you'll owe an extra $300 penalty. Exceptions include significant medical expenses, up to $10,000 to buy a first home, college costs for yourself and your children and when you take distributions from an account you inherited from a decedent. However, a mere financial hardship will not exempt you from the penalty.