Understanding IRA Penalties

by: WilliamBrightworth
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If you make a mistake investing with your IRA, penalties can severely damage your nest egg. Start with tax and early withdrawal penalties: if you pull any money out of your traditional IRA, you have to pay any taxes due (which means they count as income, potentially moving you up a tax bracket or two) and ten percent of the total amount you withdraw is also forfeit to the IRS. This can add to quite a lot of money.

With a Roth IRA your penalties are similar, but you've already pre-paid tax on your contributions, so you won't be assessed income tax on the principal. Possibly, you will owe income tax on the interest that has accumulated, and in any case you'll still get hit with the 10% IRS surcharge.

IRA penalties will always be assessed if you withdraw early from your IRA, but you may find yourself paying penalties in other situations. For example, you may have been managing your IRA yourself and invested in something the IRS considers a conflict of interest. For instance, if you put your investment in an office building you also occupy, the IRS may determine this qualifies as an early disbursement.

To make matters worse, if you over contribute, you may find yourself penalized. Penalties for over contributing include the assessment of late taxes, fines, and other charges. You want to neither over nor under contribute, but invest exactly the right amount in your IRA.

This does not mean you can never touch your IRA - after all, it's your money! A Roth is an easier source of cash than a traditional IRA, but you can withdraw from both in certain situations.

You may withdraw money from your IRA without incurring a penalty if you are purchasing a home for the first time in two years. You and your spouse are also eligible to withdraw up to $10,000 for yourself if you are using the cash for your own home, or that of your grandchildren, parents or child. The limit on this withdrawal is 10 thousand for your lifetime. You may also withdraw cash to use on certain qualified educational expenses.

In case of unemployment, your IRA may be used to pay for medical insurance, but only if you've been unemployed for 12 consecutive weeks. IRAs may also fund medical expenses if they qualify and exceed 7.5% of your gross income. If you are disabled, you may withdraw from your IRA as if you were already retried. Also, if you are a qualified reservist and called to active duty, you might be able to escape the 10% fee, although you should check with your command about this (rules are changing as we are calling more people up). Finally, in the case where your life expectancy might be dramatically shortened, you may be able to have your IRA disbursed early without penalty.

Regardless of penalization, there is no case where you should withdraw money from your IRA without good reason. IRA penalties are there to protect your retirement investment and encourage you against relying on your retirement as a rainy day fund. Protect your IRA and it will take care of you in the future, helping you live a comfortable and secure life later on!