The Tax on IRA Withdrawls

Putting money into an individual retirement account, whether a traditional IRA or a Roth IRA, is taking an active step toward securing your financial future. Both types of IRA offer tax advantages, but each in different ways. Taking money out of an IRA requires a firm understanding of potential tax liability.

Ordinary Income Tax

All traditional IRA withdrawals are subject to ordinary income tax. You are taxed at your usual tax rate on the amount you take out whenever you take a distribution from the account. On the upside, you can deduct traditional IRA contributions when you file your tax return, so you do get a tax break at the contribution end.

Early Distribution Penalty

With few exceptions, if you remove money from a traditional IRA before you reach age 59 1/2, you will have to pay a 10-percent penalty on top of ordinary income tax on the withdrawal. You can avoid the penalty if you become totally and permanently disabled, or use the money you withdraw to buy a first home. Other exceptions include paying higher education expenses and covering medical expenses that exceed 7.5 percent of your adjusted gross income.

Required Minimum Distributions Excise Tax

A traditional IRA owner must take required minimum distributions from the account every year after reaching age 70 1/2. You can calculate the yearly required minimum distribution by multiplying your IRA's end-of-year balance by figures on an IRS life expectancy table. Normally, your IRA trustee makes this calculation and disburses the amount. If you do not take the required minimum distribution, you have to pay the IRS a 50-percent tax on the amount you should have taken but did not. For example, if your required minimum distribution is $2,500 and you withdraw just $2,000 that year, you'll owe the IRS $250, or 50 percent of the outstanding $500.

Roth IRA Earnings -- Early Withdrawal

Roth IRA owners have the privilege of withdrawing principal whenever they like, without incurring tax or penalty. Earnings are a different story. You must wait until your Roth has been open for five years and you have turned 59 1/2 to take out earnings tax-free and penalty-free. If you are 59 1/2 or older but the account is not yet five years old, you only have to pay ordinary income tax on an earnings distribution. You never have to make withdrawals from a Roth, and you can continue putting in money for life.