Taking money out of an individual retirement account before you are required to do so can be harmful in two ways. First, withdrawals from a traditional IRA will reduce the amount in the account that will grow tax free. Also, any distribution may be subject to penalties from the Internal Revenue Service, the institution holding the account or investments within that account. Even pre-tax Roth IRAs may face some surrender penalties.
It's important to know the difference between a withdrawal penalty and a surrender penalty. Early withdrawals from a traditional IRA, before age 59 1/2, are subject to income taxes plus a 10 percent IRS penalty unless they qualify for a hardship withdrawal. A surrender penalty is imposed either by the institution or an investment, such as an annuity, within the IRA.
An IRA is a "holding" account that uses contributed money to invest in stocks, mutual funds, certificates of deposit or annuities. Contributions to traditional IRAs are tax deferred, while those to Roth IRAs are taxed when made, but withdrawals at retirement are exempt. Either type may be set up at a bank or other financial institution, mutual fund, investment brokerage or trust company. Many IRAs charge fees for withdrawals before a specified time, which will be explained in an IRA contract.
A termination or surrender penalty may range from $50 to several hundred dollars, depending on the type of account and institution. Some institutions charge "transfer" fees when an IRA is rolled over or moved into a different account. IRA funds in a CD may be subject to a "loss of interest" penalty if withdrawn before the scheduled termination, while most annuities have a surrender charge, typically a percentage of the amount withdrawn.
Any withdrawal or surrender of an IRA before age 59 1/2 may be subject to IRS penalties. Those are in addition to ordinary income taxes with a traditional IRA but apply to a Roth IRA only when the money has been in the account less than five years. Rollovers into another similar retirement account typically escape the penalty, although a transfer from a traditional IRA to a Roth IRA is subject to income tax.
- IRS: Individual Retirement Arrangements (IRAs)
- fnCentral.com: Your Guide to Understanding IRA Fees
- TD Bank: Tax-Deferred Accounts
- Credit Union National Association: Roth IRA Early Withdrawals May Prompt Penalties
- eTrade: Surrender or Termination Fees
- Securities and Exchange Commission: Variable Annuities
Bob Haring has been a news writer and editor for more than 50 years, mostly with the Associated Press and then as executive editor of the Tulsa, Okla. "World." Since retiring he has written freelance stories and a weekly computer security column. Haring holds a Bachelor of Journalism from the University of Missouri.