Do You Pay Tax on the Full Amount or Post-Penalty Amount on an Early Withdrawal From an IRA Tax?
The factors that influence the income taxes on your individual retirement account distribution don't include the amount, if any, of the early withdrawal penalty. The Internal Revenue Service doesn't offer any deduction for early withdrawal penalties. If you're hit with an early withdrawal penalty, it only applies to the taxable portion of the distribution.
When Penalties Apply
IRA early withdrawal penalties only apply when you're taking an early withdrawal from your account. For traditional IRAs, the rule is simple: if you're under 59 1/2 when you take the withdrawal, it's an early withdrawal. For Roth IRAs, there's two criteria you must meet and, if you don't meet both, it's an early withdrawal. First, your Roth IRA must have been open for five years. Second, you must be either 59 1/2, permanently disabled, taking out up to $10,000 for a first home or taking money from an inherited IRA.
Taxable Traditional IRA Withdrawals
When you're taking withdrawals from a traditional IRA, the entire amount gets hit with income taxes unless you've put in non-deductible contributions. Non-deductible contributions refer to money that you don't get a deduction for. You don't get to choose which dollars you take out first. Instead, the money you take out gets prorated with the non-deductible contribution portion coming out tax-free -- and penalty-free. For example, say 15 percent of your IRA is from non-deductible contributions and you take out $10,000 when you're 55. Only $8,500 is taxable, but the $8,500 is also hit with the early withdrawal penalty.
Taxable Roth IRA Withdrawals
If you're taking money out of a Roth IRA, you only have to pay taxes on an early withdrawal. Qualified withdrawals come out tax-free. But, even if you're taking an early withdrawal, you might get out of both the taxes and the penalties if you're only taking out your contributions. But, once you exhaust all your contributions, you start taking out earnings, which are taxable are hit with the early withdrawal penalty.
The only way out of the 10 percent early withdrawal penalty is if you qualify for an exception. For example, if you're permanently disabled or you're taking out a qualified reservist distribution, you can take out as much as you want without penalty -- but you'll still owe any applicable taxes. Other exceptions let you withdraw up to the amount you pay in health insurance when you're out of work, medical expenses exceeding 7.5 percent of your adjusted gross income or higher education expenses.
Based in the Kansas City area, Mike specializes in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."