Today we shall take a look at traditional IRA withdrawal rules. Hopefully, by reading through this article, you will gain all the knowledge you need to establish whether you have what it takes to open and sustainably save for retirement through a traditional IRA. Take your time to read through carefully, and if you come across anything that you think needs clarification, head to the comments section and drop me the query. Without further ado, let’s get right into it.
Traditional IRAs can be a great solution to those who are trying to increase their tax-deferred retirement savings. A traditional IRA, along with other retirement plans such as SEP and SIMPLE IRAs, allows you to contribute on a pre-tax basis, provided that your income meets the required qualifications set by the IRS. You will not have to pay any taxes until it is time to withdraw your retirement savings. You, however, have to know all the rules that apply to traditional IRA withdrawals lest you end up colliding with the taxman, and paying a lot of money in taxes and penalties.
Early Withdrawals – Age 59 ½ and under
A traditional IRA account holders’ deductible contributions and earnings (this includes interest, capital gains, and dividends) are usually taxed as ordinary income. The IRS hits those who take early withdrawals with a 10% penalty, in addition to the state tax penalty. There are, however, some instances in which you may avoid the penalty as you take early withdrawals. Such instances include:
First-time home purchases
The IRS allows traditional IRA account holders to use the funds saved up in their IRA to make first-time home purchases. You can only withdraw $10,000 for this need (this is the set pre-tax lifetime limit), and you are required to use those funds within 120 days.
Funding higher education expenses
You can use the funds saved up in your account to cater to your higher education expenses. You can also take early withdrawals to meet the higher education expenses for your spouse, children, and grandchildren.
Permanent disability and death
If you are disabled, the IRS allows you to withdraw your IRA funds without being penalized. In the event that you also pass away, your beneficiaries can also take early withdrawals with no penalties.
Birth or adoption
In the year that you become a parent by birth or adoption, you can withdraw up to $5000 from your traditional IRA, to meet your parenting expenses, with no penalties.
Meeting medical expenses
If you have unreimbursed medical expenses that exceed 7.5% of your adjusted gross income (AGI), you can use the funds in your traditional IRA, with no early withdrawal penalties.
Those who are unemployed for at least 12 weeks are allowed to withdraw the funds in their account to pay the health premiums of themselves, their spouse, or other dependents.
As a member of the National Guard or as a reservist, you are allowed to take penalty-free distributions, upon being notified that you will be on active duty for not less than 179 days. You should, however, confirm whether you qualify for the early withdrawal penalty exemptions.
By choosing to receive your traditional IRA funds through a regular distribution schedule, you get the chance to avoid early withdrawal penalties. You can contact your traditional IRA service provider to establish how you can receive your regular distributions over time.
If you have a distribution that is a result of an IRS tax levy, you can refer to IRS Form 5329, on how to claim your tax penalty exceptions.
No Withdrawal Restrictions – Taking Withdrawals at age 59 ½ and over
Upon reaching age 59 ½, you can start withdrawing your funds from your traditional IRA without any fear of restrictions and penalties. The IRS allows you to make penalty-free withdrawals at any time. You, however, have to recall that you made tax-deferred contributions, so your deductible contributions and earnings will all be taxed in the same manner as your ordinary income. In short, you will now owe the IRS all the taxes that you originally deferred.
You are allowed to keep taking advantage of your tax-deferred contributions, no matter what age group you are in, provided that you have an earned income.
Required Minimum Distributions – Age 72 and over
Upon turning 72, you are necessitated to start taking your annual Required Minimum Distributions, popularly abbreviated as RMDs, from your traditional IRA. The IRS rules demand that you take your first RMD by April 1 of the year that follows the one in which you reach age 72. In every year that comes after you take the first RMD, you are required to take an RMD by the end of the year (December 31).
How does the IRS arrive at your RMD? The RMD is obtained by dividing the total value of your traditional IRA, by a certain life expectancy factor. The life expectancy factor is also determined by the IRS.
You can, of course, withdraw more than your RMD, but you should not forget that all distributions are taxed as ordinary income. You should also take note of the fact that the failure to take RMDs attracts a 50% penalty on the amount of money that you were required to withdraw.
If you have planned out your finances in such a way that you do not see the need to take the RMDs to help you to meet your living expenses, what should you do with your money? There are many options for you, and that includes looking for ways to keep the money working for you. You can for instance:
- Contribute the funds to a 529 savings plan to help your relative attend college
- Make a current year contribution to your IRA
- Invest in a brokerage account
Also, instead of watching your money get eaten into by inflation, you can consider opening a gold IRA. Check out our review of the highly recommended gold & silver IRAs below:
That will be all for this article on traditional IRA withdrawal rules. Hopefully, you gained information that will help you get started with investing in a traditional IRA more confidently. You can also check out what other options there may be for you so that you maximize your income earning potential and shield yourself from inflation. Let me know if you have any questions pertaining to today’s article- drop them in the comments section, and I will get back to you ASAP.
I wish you well,
Eric, Investor and Team Member at Gold Retired.