IRS Withdrawal Penalties
- If you have a retirement plan such as a 401(k) or a Roth or traditional IRA, the IRS requires you to leave that money in the account until you turn 59 1/2. Although this rule has some exceptions, such as removing the money to buy a house or pay for college, the IRS will penalize you if you do not follow this key withdrawal rule. In addition, although not a penalty, the IRS will tax your withdrawal if it is money you had set aside pre-tax.
- The IRS will levy a penalty of 10 percent of the amount of money you withdraw from your retirement fund if you make the withdrawal prior to turning 59 1/2. This applies to all retirement accounts including Roth IRAs, traditional IRAs and 401(k)s. For example, if you withdraw $20,000 at the age of 40, the IRS will penalize you by taking $2,000.
- The early withdrawal rule has exceptions. Specifically, the IRS exempts first-time home buyers who have a traditional or Roth IRA. These individuals may use up to $10,000 penalty-free toward the down payment of a new home. However, the IRS will levy a penalty on all money withdrawn beyond $10,000 at the standard 10-percent rate. This means if an individual withdraws $20,000 to pay for a new home, he will be penalized $1,000.
- The exception for a first-time home purchase has another caveat. If you withdraw up to $10,000 to pay for the cost of a new home, you must use this money within 120 days of withdrawal to avoid being penalized. According to Bankrate.com, the time limit applies to buying, building or rebuilding a home as well as to paying any usual settlement, financing or closing costs.
- Penalties apply to early withdrawals from a SIMPLE (Savings Incentive Match Plan for Employees) IRA, which is a retirement plan that some small businesses provide to employees. Like a 401(k), it is funded with salary deferrals and employer matching contributions. As with traditional and Roth IRAs, the IRS will penalize those who withdraw from a SIMPLE IRA before the age of 59 1/2. However, if the withdrawal is made within the first two years of joining the retirement plan, the penalty shoots up to 25 percent. This means if you withdraw $20,000 from a SIMPLE IRA and you do not meet any exemption, you will owe the IRS $5,000 in penalties.