Ways To Avoid A Tax Hit With An IRA Withdrawal
When planning for your financial future, an individual retirement account (IRA) is one of the basic building blocks to ensure you save up enough money for retirement. But as you’re working towards those retirement goals, sometimes you’ll come across a need to tap into your IRA savings to help pay for an unexpected expense. While these instances should be kept at a minimum so your retirement plans can stay on track, sometimes they are necessary, and that’s why you’re able to engage in an IRA withdrawal. Before you consider doing so, you should be fully aware of the tax implications of an IRA withdrawal so you can minimize how much of your money is lost to taxes.
Are any IRA withdrawals tax-free?
There are a few specific instances where you won’t be hit with taxes for an IRA withdrawal. If you chose to invest in a Roth IRA, then all of your contributions have already been taxed before. For other IRAs, they are put into your investment account on a pre-tax basis, meaning you can accrue wealth on those pre-tax investments. Still, you are liable to pay taxes on the original investment, and the amount accrued over time. However, it’s important to note that taking the money out of your Roth IRA without being taxed requires you to wait and won’t withdrawal before the designated time. It must be in the account for at least five years, and you must have reached at least 59.5 years of age. If neither of these applies, you can’t take out anything tax-free.
If you do need to make a withdrawal from your Roth IRA at 59 years or younger, you can still avoid taxes by only taking out money from your original contributions, rather than the gains that money has earned over time. Doing this requires the help of a financial advisor to make sure it’s done correctly and is properly logged, but this can also help you use your Roth IRA funds without getting taxed.
Outside of this, what are the typical taxes?
Assuming you used a traditional IRA, then you are likely going to encounter taxes no matter when or how you withdraw from the IRA. As previously noted, the IRA contributions were not taxed as you put them in, so you do owe taxes. Additionally, if you hit a road bump in your financial journey and are withdrawing these funds at an early age, you will be subject to an additional 10% tax penalty. This penalty is there because the purpose of an IRA is really for retirement planning, so incentives are included to make sure you don’t dip into the pot early.
Are there exceptions?
Yes, there are exceptions where you can engage in an IRA withdrawal without being subject to the typical tax penalties for an early IRA withdrawal before the age of 59.5. For example, if your IRA withdrawal is to pay for a medical expense that your health insurance won’t cover and exceeds 10% of your income, then you will not be charged the early withdrawal penalty. The same can be said for instances where you need to pay for health insurance during extended unemployment, you’re purchasing your first home, it’s for college or university costs, and more.
When trying to avoid the tax penalties of withdrawing from your IRA early, you should contact a financial advisor, such as Tobin & Collins, who is well trained in these areas. The rules are periodically changing, and they’ll best be able to determine if you qualify for these or any other exceptions. Contact us today!