Withdrawing money from an IRA account is as simple as contacting the financial institution that holds your IRA account and informing them that you wish to withdraw the funds and signing the appropriate paperwork. However, the process and the potential tax and penalty consequences require careful consideration to make informed decisions about IRA withdrawals.
Investment Decisions in IRA
It may be necessary to instruct your financial institution on which assets to sell in your IRA, depending on how your IRA funds are invested. For example, if you own mutual funds or stocks and bonds in your IRA and are withdrawing the entire IRA, everything in the IRA will be sold. If you only need some money from your IRA, you may be asked to decide which mutual funds, stocks, or bonds you would like to sell.
If you do not plan to spend the money but instead wish to transfer your IRA to another broker, you can transfer it from an IRA at one institution to an IRA at another. With a transfer, funds are not actually withdrawn from the IRA; instead, you move IRA money from one IRA account to another IRA account. Transfers are not subject to income taxes or penalties as long as you follow IRS rules for transfers.
When Can You Withdraw Money from an IRA?
You can withdraw money from an IRA at any time. However, withdrawing money from an IRA before reaching age 59 and a half and not meeting certain exceptions from IRS rules will result in a 10% penalty tax on the amount withdrawn. Additionally, traditional IRA distributions are considered taxable income. Any distribution will be reported by your broker to the IRS during the tax year in which the distribution occurs, so it’s important to remember to claim it as income when filing your annual tax return as well.
Note: It is not about when you can withdraw money from the IRA, but rather about the amount of taxes and penalties you will pay if you withdraw money from the IRA at the wrong time.
How Much Do You Pay in IRA Withdrawal Taxes?
Any money withdrawn from a traditional IRA becomes taxable income in the year it is withdrawn. The amount of tax you will pay depends on your marginal tax rate in that year, which is based on your other total income and your deductions.
If you have no other income in the year you are withdrawing from the IRA and you have sufficient deductions, it is possible to avoid paying any taxes at all.
IRA Withdrawal Mistakes to Avoid
Accumulating debt can be frightening. Severe debt can be terrifying. Withdrawing money from an IRA might seem like your only option to relieve increasingly mounting anxiety, but think carefully before using this option. Even if your immediate financial burdens are exacerbated, IRA funds are protected by certain restrictions from creditors in the event of bankruptcy. Withdrawing money from an IRA undermines the valuable protection for the creditor outlined below. Up to $1,362,800 of traditional or Roth IRA can be protected from bankruptcy claims under federal law if you made direct contributions to the account, meaning this protection may not extend to an IRA account you left as an inheritance, for bankruptcies occurring between April 1, 2019, and March 31, 2022. (This figure is adjusted for inflation every three years.) The entire account balance is protected if the funds were rolled into an IRA from a company plan (such as a 401(k) or 403(b) plan). IRA assets may be protected from creditor claims outside of bankruptcy. Laws vary significantly from state to state.
Note:
Always check with a lawyer in your state regarding assets that creditors can track. Rules vary from state to state.
Best Time to Withdraw Funds from IRA
As the name suggests, the best time to withdraw funds from an IRA aligns with a smart withdrawal plan. A comprehensive and smart withdrawal plan addresses the expected annual income for each year of retirement and the Social Security start date, taking into account retirement and any other sources of income, and then estimates your tax situation in retirement. All the information comes together to decide in which years larger or smaller amounts should be withdrawn from the IRA.
When Should You Withdraw Funds from IRA?
For a traditional IRA (not a Roth IRA), the minimum required withdrawal must be taken after reaching age 72 (or age 70½ if you reached age 70½ before January 1, 2020). The amount of the required withdrawal is determined by a formula that is recalculated each year, based on age and account balance at the end of the previous year.
Withdrawing Funds from Roth IRA
The rules discussed above apply to traditional IRAs where you made deductible contributions. Roth IRA withdrawals are similar but are subject to a different set of tax rules.
Frequently Asked Questions (FAQs)
How does withdrawing funds from an IRA affect your credit score?
Your credit score is a measure of how you manage debt, so an IRA does not affect your credit score in any way. Having money in an IRA will not improve your credit score, and withdrawing funds will not harm it.
How do you pay penalties for withdrawing funds from an IRA?
If you need to pay penalties on early IRA withdrawals, you can settle this obligation at any time you want, as long as it’s done before tax day. You can choose to have taxes withheld from the initial distribution, or you can wait until later and pay the taxes separately to the IRS.
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Sources:
– Fidelity. “IRA Withdrawals.”
– IRS. “Rollovers of Retirement Plan and IRA Distributions.”
– IRS. “Hardships, Early Withdrawals and Loans.”
– IRS. “Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs) for Use in Preparing 2019 Returns,” Page 14.
– EveryCRSReport.com. “The “Bankruptcy Abuse Prevention and Consumer Protection Act of 2005,” S. 256, in the 109th Congress,” Page 7.
– Financial Planning Association. “Creditor Protection for Retirement Accounts: ERISA, the Supreme Court, and the Bankruptcy Act of 2005,” Page 1.
– IRS. “Publication 590-B (2019), Distributions From Individual Retirement Arrangements (IRAs).”
– IRS. “Retirement Topics — Required Minimum Distributions (RMDs).”
– IRS. “Publication 590-B, Distributions From Individual Retirement Arrangements (IRAs) for Use in Preparing 2019 Returns,” Page 28.
Source: https://www.thebalancemoney.com/how-to-take-money-out-of-an-ira-2388694
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