Taking money out of an IRA is as easy as calling the financial institution where your IRA account is held, telling them you would like to take money out, and signing the appropriate paperwork. But the process, as well as potential tax and penalty consequences, require thoughtful consideration to make informed decisions on IRA withdrawal.
Cornerstone IRA Investment Decisions
It may be necessary to direct your financial institution as to which assets in your IRA to sell depending on how your IRA funds are invested. For example, if you own mutual funds or stocks and bonds in your IRA and are cashing in the entire IRA, then you would sell everything in the IRA. If you only need some of the money in your IRA, you may be asked to decide which mutual funds, stocks or bonds to sell.
If you're not planning to spend the money but instead want to move your IRA to another brokerage, you can transfer money from an IRA at one institution to an IRA at another institution. With a transfer, the funds are never really taken out of an IRA – instead, you are moving the IRA money from one IRA account to another. IRA transfers are not subject to income taxes or penalty taxes provided you follow IRS rules for governing the transfer.
When Can You Take Money Out of an IRA?
You can take money out of an IRA anytime. But taking money out of an IRA prior to reaching age 59 ½ and failure to meet certain IRS exceptions will result in a 10 percent penalty tax on the amount withdrawn. Additionally, traditional IRA distributions exist as taxable income. Any disbursement by your brokerage will be reported to the IRS within the tax year which it was disbursed; so it's important to remember to claim it as income, in filing your own annual tax return as well.
Bottom line: it’s not a matter of when you can take money out of an IRA; it’s a matter of how much in taxes and penalties you’ll pay if you take money out of your IRA at the wrong time.
How Much You Pay in Taxes on IRA Withdrawals
Any money withdrawn from a traditional IRA becomes taxable income in the year it is withdrawn. The amount of taxes you will pay depends on your marginal tax rate that year – which depends on your total other income and deductions.
If you have no other income the year you take an IRA withdrawal and you have sufficient deductions, it is possible to avoid paying any taxes at all.
IRA Withdrawal Mistakes to Avoid
Mounting debt can be a scary thing. Crushing debt can be terrifying. Taking money out of an IRA may seem like your only option to ease the ever-growing worry, but think carefully before using this option. Even if your immediate financial burdens compound, IRA money is protected with certain limitations from creditors in the case of bankruptcy. Taking money out of your IRA cripples the valuable creditor protection described below.
- Up to $1,362,800 of Traditional or Roth IRA money may be protected from bankruptcy claims under federal law if you contributed directly to the account -- meaning this protection may not be extended to an IRA account that you inherited -- for new bankruptcy filings between April 1, 2019 and March 31, 2022 (this figure is inflation-adjusted every three years.).
- The entire IRA account balance is protected if the money was rolled over to an IRA from a company plan (such as a 401(k) or 403(b) plan).
- IRA assets may be sheltered from creditor claims other than bankruptcy. This is determined by state law and laws vary widely from state to state.
Disclaimer: it is always best to check with an attorney in your state on which assets creditors can go after. Rules vary by state.
The Best Time to Take Money Out of an IRA
As the name implies, the best time to take money out of an Individual Retirement Account (IRA) complies with a smart withdrawal plan. A smart, comprehensive withdrawal plan addresses expected annual income each year in retirement and the starting date of Social Security; considers pensions and any other sources of income, and then estimates your tax situation in retirement. All information combines to decide which years larger or smaller IRA withdrawals should be taken.
When Are You Required to Take Money Out of an IRA?
For a traditional IRA (not a Roth IRA) withdrawals called required minimum distributions must be taken soon after reaching the age of 72 (or age 70½ if you turned 70½ before January 1, 2020). The required withdrawal amount is determined by a formula that is recalculated each year, based on age and prior year-end account balance.
Taking Money Out of a Roth IRA
The rules discussed above apply to traditional IRAs where you made deductible contributions. Withdrawals from Roth IRA are similar but fall under a different set of tax rules.