Federal Tax Rules on IRA Withdrawals
- Congress created the IRA to help Americans save and invest for retirement.older couple image by JulianMay.co.uk from Fotolia.com
The IRA was conceived by the U.S. Congress in 1974 to help folks who wanted to invest retirement savings and also save on taxes. Contributions may be deductible in whole or in part. Earnings on these investments are not subject to such taxes as capital gains. To ensure IRA funds would be used for retirement purposes, the IRS put in place strict rules relative to contributions and withdrawals. - According to the IRS, "you must start receiving distributions by April 1 of the year following the year in which you reach age 70-1/2." This rule was established to ensure that the tax-deferred money you have accumulated will be used for retirement purposes. If not for this rule, some might be tempted to let earnings accrue tax-deferred for the benefit of their heirs. You must make these withdrawals yearly in amounts determined by the IRS (and typically calculated by your IRA trustee), or be subject to a hefty 50 percent tax penalty.
- Under certain circumstances, "[i]f you made IRA contributions in 2009, you can withdraw them tax-free by the due date of your return," according to IRS Publication 590. The IRS regards this type of withdrawal as a returned contribution. To take advantage of this rule, you must not have taken a tax deduction when you made the contribution and you must withdraw not only the contribution but any earnings on it that have accrued. You will have to pay a 10 percent penalty on those earnings, but not on the contribution amount. If your account suffered a loss, this may mean you will end up withdrawing less than what you contributed. As the IRS terms it, "the net income earned on the contribution may be a negative amount." You can calculate the amount of earnings on your contribution, positive or negative, by using an IRS worksheet. In addition, the IRS says, "if you made more than one regular contribution for the year, your last contribution is considered to be the one that is returned to you first."
- If contributions to your IRA exceed the yearly limit, you have made excess contributions. If, before you reach age 59-1/2, you withdraw this excess amount by the due date of your tax return for that year, you will not have to pay income tax or 10 percent early withdrawal penalty on the amount of the excess contribution. If the excess contribution has earned any interest, you will have to pay a 10 percent penalty on the interest amount. For example, if you are 28 years old and contribute $5,800 to your IRA in 2010, you have exceeded your contribution limit by $800. As long as you withdraw the $800 by April 15, 2011, you will not be subject to income tax or penalty. If, however, the $800 has earned interest, you will have to report the interest as income and pay an additional 10 percent tax on that amount. If you obtain an extension to file your taxes, you also extend the date by which you must withdraw the excess contribution. Excess contributions withdrawn after your tax filing due date may be subject to a 6 percent tax according to IRS Publication 590.
