As you start building up the balance in your Individual Retirement Account, it may be tempting to tap it for things you want or need today. After all, it’s your money, and your post-work life may still be decades away. But withdrawing money from an IRA will cost you—both today and when you’re ready to retire later.
Why? What happens when you make a withdrawal?
It all depends on which IRA you have.
Traditional IRA. You’ve already paid income taxes on money you contribute to a traditional IRA, but you may be able to deduct it, which can lower your tax bill today. You’ll also pay income taxes on this money once you start taking distributions in retirement, which the IRS says is anytime after age 59 ½. Take out any cash before then, and you’ll owe regular income taxes, plus, in most cases, a 10-percent penalty.
SEP IRA. Simplified Employee Pension (SEP) IRAs—the account for side giggers and other self-employed people—works in much the same way: Any money withdrawn before age 59 ½ is subject to regular income tax and a 10-percent penalty.
Roth IRA. A major perk of Roth IRAs is that because you’ve already paid taxes on the money you contribute today, you don’t pay taxes on what you withdraw in retirement. That means you can access your contributions anytime without penalty. However, if you tap any investment earnings (a.k.a. the market returns your invested money has generated) before you’re 59 ½—or before you’ve had your account open for at least five years—you’ll owe income tax, plus the 10-percent penalty.
Is there any way around these penalties?
You can avoid the penalties on early withdrawals if you’re using the money (up to a max of $10,000) to buy, build or rebuild a first home or need it due to a disability. You’ll still owe income taxes on money taken from a traditional or SEP IRA.
Just keep in mind that withdrawing money from any account meant for retirement means you’ll need to double up on savings to get back to where you started. You’ll also be forfeiting any gains your money might’ve generated over time—which, thanks to compounding returns (when your returns earn returns, and so on), could add up to a lot.
This information is being provided for informational purposes only, and is not intended to provide, and should not be relied on for, accounting, legal or tax advice. You should consult your tax or legal adviser regarding such matters.
August 27, 2018