Table of contents
Withdrawal penalty

Both a traditional and Roth IRA can play an important role in any retirement plan. These accounts offer important tax advantages at either the time of contribution or in retirement, but they also have some pretty specific rules regarding when that money can be accessed.

Read on to learn the rules retirees need to follow when accessing their tax-advantaged savings accounts. We’ll also go over what qualifies as an early withdrawal from these accounts, the IRA withdrawal penalty rules, and how to avoid paying any of these penalties on distributions when taking money out of an IRA.

What are withdrawal penalties?

As the name implies, a withdrawal penalty is a fee imposed when an account holder pulls money out of certain types of savings vehicles ahead of schedule. This fee is typically triggered when withdrawing savings earlier than the timeline allowed by the institution or the nature of the account itself. 

Early withdrawal penalties are commonly seen on various types of “locked” savings accounts, such as those held at financial institutions operating under federal regulation. These penalties could affect everything from certificates of deposit (CDs) to individual retirement accounts (IRAs), 401(k)s, and more. These fees may be accompanied by additional taxes and, depending on the type of account, premature account closure.

Understanding withdrawal rules on a traditional and Roth IRA

Both traditional and Roth IRAs are subject to certain federal regulations. These IRA withdrawal rules dictate when funds can (or must) be withdrawn and the penalties imposed for withdrawing funds early.

Traditional IRA 

With traditional IRAs, employees are able to save for retirement with tax-deductible dollars. These savings (up to $6,000 per year for 2021 and 2022, or up to $7,000 for those 50 and older) grow tax-free until retirement, when they can be withdrawn and then taxed as ordinary income.

Standard withdrawals of contributions and growth are allowed beginning at the IRA withdrawal age of 59½. Any withdrawals taken then are subject to ordinary income taxes, at the owner’s  tax rate in the year of the withdrawal. 

Once the account holder reaches a certain age, they must begin withdrawing funds (known as required minimum distributions, or RMDs). Failure to withdraw these funds can result in a 50% excise tax on the portion of the RMD that wasn’t distributed. Before 2019, this age was 70½; thanks to the SECURE Act, retirees can now wait until age 72 for RMDs.

If funds are withdrawn from a traditional IRA before age 59½, the account owner is subject to an IRA early withdrawal penalty tax of 10% on top of the income taxes they must pay on the funds. However, there are exceptions to this blanket rule. 

Withdrawals from a traditional IRA before age 59½ are not subject to early withdrawal penalties in the following situations:

  • An investor becomes disabled. If an investor becomes disabled before age 59½ and is unable to remain gainfully employed, they can withdraw from their IRA to pay for expenses related to their disability, without penalty. 
  • An investor gives birth to or adopts a child. Up to $5,000 per child can be withdrawn from a traditional IRA to pay for expenses related to birth or adoption. These funds can also be repaid into the account.
  • An investor has unreimbursed medical expenses. If an investor had medical expenses that were not reimbursed and accounted for more than 7.5% of their adjusted gross income (AGI), they don’t have to pay the 10% penalty tax on the amount they spent beyond 7.5% of their AGI. 
  • An investor loses a job and needs to pay medical insurance premiums. Investors who lose a job can use their IRA to pay for qualifying medical insurance premiums for themselves, their spouse, and their dependents, without early withdrawal penalty. They’ll need to meet certain IRS requirements to qualify.
  • An investor pays higher education expenses. Some or all of an early distribution may be exempt from penalty if an investor used the funds for higher education expenses. These might include qualifying educational expenses (tuition, books, fees, room and board) for themselves, their spouse, children, or grandchildren.  
  • An investor buys or builds a first home. Early withdrawal penalties are waived on up to $10,000 in early IRA withdrawals if investors buy, build, or rebuild their first home. These qualified acquisition costs must meet certain requirements; an investor and their spouse can take advantage of the exclusion from their individual accounts for a maximum of $20,000 combined.
  • A reservist is ordered or called to active duty. Qualified reservists can withdraw from their IRA without penalty if they were ordered or called to active duty service after September 11, 2001.

Under the CARES Act, IRA account holders could also withdraw money in 2020 without penalties. This money could be used for any number of hardship-related expenses due to the pandemic and could be repaid if borrowers wished.

Roth IRA 

With a Roth IRA, the rules are a bit different because Roth IRA contributions are made with after-tax dollars. There are no tax deductions on contributions, so they can be withdrawn at any time without penalty.

Any earnings on those contributions, however, follow a different set of rules. For starters, there is no required minimum distribution (RMD) for a Roth IRA. The money can sit in the account for the rest of the account holder’s life. When the account holder dies, the beneficiary must take all withdrawals within 10 years. 

To withdraw earnings from a Roth IRA, two primary requirements must be met: Investors must be at least age 59½ and the account needs to have been open and funded for at least five years. 

Withdrawals of earnings before age 59½ or meeting the five-year rule may be subject to the early withdrawal penalty tax of 10%. Exceptions are the same as traditional IRAs, so investors can avoid the penalty if they:

  • Become disabled
  • Give birth to (or adopt) a child
  • Have unreimbursed medical expenses
  • Lose a job and need to pay health insurance premiums
  • Paid certain higher education expenses
  • Buy or build a first home
  • Are a reservist ordered or called to active duty
Receive daily business and financial news
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

The bottom line

Individual retirement accounts, or IRAs, can be an important retirement savings tool that offers tax advantages. The IRS provides guidelines to help investors avoid triggering a taxable event and/or being subject to early withdrawal penalties.

Investing well for retirement is a crucial act. At Titan, our expert investment analysts steward your capital through actively-managed, high growth-potential portfolios. Sign up takes minutes, and our Client Experience team is here to help you step-by-step as you migrate your retirement funds over to Titan. Get started today.
Disclosures

Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, Titan has not independently verified such information and makes no representations about the accuracy of the information or its appropriateness for a given situation. In addition, this content may include third-party advertisements; Titan has not reviewed such advertisements and does not endorse any advertising content contained therein.

This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any strategy managed by Titan. Any investments referred to, or described are not representative of all investments in strategies managed by Titan, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results.

Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see
Titan’s Legal Page for additional important information.

Become a Titan investor today.
Create an account with us in two minutes.
JOIN NOW

Receive daily business and financial news
Thank you! Your submission has been received!
Oops! Something went wrong while submitting the form.

Investing well for retirement is a crucial act. At Titan, our expert investment analysts steward your capital through actively-managed, high growth-potential portfolios. Sign up takes minutes, and our Client Experience team is here to help you step-by-step as you migrate your retirement funds over to Titan. Get started today.
Disclosures

Certain information contained in here has been obtained from third-party sources. While taken from sources believed to be reliable, Titan has not independently verified such information and makes no representations about the accuracy of the information or its appropriateness for a given situation. In addition, this content may include third-party advertisements; Titan has not reviewed such advertisements and does not endorse any advertising content contained therein.

This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any strategy managed by Titan. Any investments referred to, or described are not representative of all investments in strategies managed by Titan, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results.

Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Past performance is not indicative of future results. The content speaks only as of the date indicated. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in these materials are subject to change without notice and may differ or be contrary to opinions expressed by others. Please see
Titan’s Legal Page for additional important information.

Become a Titan investor today.
Create an account with us in two minutes.
JOIN NOW

Keep reading