What is the Tax Penalty for Cashing in IRA Early

An Individual Retirement Account, or IRA (what is an IRA?), provides a tax free or a tax deferred way that people can save for retirement. There are several different types of IRA accounts. A traditional IRA allows for contributions of a maximum of $4000 every year. It could be more if the person is over the age of 50. Another type of IRA is called a Roth IRA (how much can you contribute to a Roth IRA?). This type of IRA was created in 1997 to assist middle class Americans. Roth IRAs are not tax deductible, however they provide more flexibility than a traditional IRA. Money that is put into this type of IRA can be taken out at any time without extra fees or penalties. Another type of IRA is the SIMPLE IRA. This type of IRA is provided by employers that allow employees to put aside money and put it into investments so they can grow over time. There can be tax penalties if you cash in your IRA early.

Tax Penalty For Cashing In An IRA

For IRAs that our tax deferred, penalties are incurred if the person is younger than 59 ½. For a Roth IRA, penalties are incurred for people who are younger than 59 ½, as well as if the account has been open for less than five years.

The amount of the early withdrawal of an IRA account that is taxable is determined by what type of IRA account a person has. For tax deferred IRAs, the portion that is taxable includes the entire amount of the account. For Roth IRAs, the only portion that is taxable is the amount that comes from earnings. For a Roth IRA, taxes are paid on an early withdrawal if the amount of the contribution is more than the original contribution amount. In order to find out how much of the withdrawal amount comes from earnings, and how much comes from contributions, you have to use the form 8606. This form is provided by the IRS, or you can download it from the Internet.

The IRS incurs a 10% penalty of the withdrawal amount you wish for. For a tax deferred IRA, this is 10% of the entire amount of the account. For Roth IRAs, the penalty applies to 10% of the money that is deposited through earnings. The penalty for closing out a simple IRA is 25% if the withdrawal is done within two years of the account being set up. You can figure out the amount of the penalty by using form 5329. Again this form can be attained by the IRS, or by going on the Internet.

Exceptions Of Tax Penalties For Cashing Out An IRA

The Internal Revenue Service allows exceptions of penalties of an early withdrawal of an Ira for certain circumstances. If a person becomes disabled permanently, the penalties to not apply. Also, if a person has a Roth IRA, and it has been open for at least five years, the amount that you withdraw from your earnings are tax free.

If the person is using the money in the IRA account to pay for medical bills while on extended time off from work the penalty does not apply. The penalties are also waived if the owner of the IRA dies.

The penalties are waived if a person uses the withdrawal amount for a first time home purchase. The tax penalty is also not valid if the amount is used for paying back taxes to the IRS.