An IRA is a type of retirement savings vehicle designed by the US government to encourage retirement savings for later in life, for use during retirement years. The US government encourages private citizens of US to be independent in matters of their future income because of the decline in the corporate and government pensions and budget threats to Social Security.
It is in the best interest of the government to assess penalties for early IRA distributions, otherwise, the social goal of having people save for retirement could be undermined by savers using their retirement savings prior to retirement. IRS defines these premature IRA distributions as those taken prior to age 59 1/2. Let's illustrate how you can stay away from some of the penalties associated with early IRA distributions.
In case you are holding a traditional IRA, which means that the money was contributed before paying any tax, for every early distribution IRA that you withdraw before you are 59½ years of age, you have to pay a penalty of 10% in addition to the normal income tax (federal and state).
Obviously, there are certain exceptions to this early IRA distribution law and you want to qualify for such an exception. For example, if you become disabled or face significant medical expenses, you may be able to withdraw a portion of your IRA balance without paying penalties on early IRA distributions. You are also eligible for a penalty-free early IRA distributions if you have qualify for the exemptions relating to expenses for higher education or for acquiring your first home (up to $10,000). Note that this paragraph is a summary and greater details can be found here on early IRA withdrawals with0ut penalty.
You still have to pay usual income tax for these IRA withdrawals because the funds invested in your conventional IRA have never been taxed. When it comes to penalties on early Roth IRA distributions, they are a bit tricky. As the money contributed to this type of account has already been taxed, no tax needs to be paid on the original withdrawn contributions. However, if you plan to withdraw the gains these funds have accrued while invested in your Roth IRA, you may face early distribution Roth IRA penalties.
In the case of a Roth IRA, if you are older than age 59 ½ and have had the funds you plan to withdraw invested in your Roth IRA for at least five years, you will not be subject to early IRA distribution penalties on your withdrawal. But if you are not in a position to meet these criteria, then you are likely to pay an early distribution IRA penalty of 10%, on the taxable part of the withdrawal i.e the earnings. The taxable portion includes only the interest-based growth of your account funds, not the funds you originally contributed yourself.
It's possible to incur penalties on premature IRA distributions for withdrawals that are taken from IRA accounts that have been just converted from a conventional IRA to a Roth IRA. For example, such a conversi0n pri0r to age 59 1/2 is subject to penalty. Prior to making any transactions with your IRA or even company retirement accounts, a skilled tax planner may help you to evaluate potential early penalties on IRA distributions and devise ways that will help in minimizing them during withdrawals.