IRA Withdrawals: Timing Is Everything

When You Might Consider an Early Withdrawal From Your IRA

Sometimes life happens, and individuals might look to their IRA as a source of funding – whether it’s to make a large purchase or to pay off a debt that might be holding them back from achieving their retirement dreams. To be clear, you can withdraw some or all the funds in your IRA at any time, for any reason. However, upon making a distribution:

• The funds withdrawn will be considered taxable income for that year’s taxes.
• If you are under the age 59½ at the time of the distribution, you may be subject to an additional 10% tax. If withdrawing from SIMPLE IRA within the first two years of participating, the additional tax is 25%.

Let’s say you had a medical procedure and have an outstanding $25,000 medical bill that you decide to pay off using an IRA distribution. First, you would need to include that $25,000 as income on this year’s taxes. In addition, you will be required to pay an additional $2,500 (or 10%) if you’re under age 59½. For most IRAs, once you’ve reached 59½, you can begin to withdraw for no reason without penalty – but before then, it’s a costly way to borrow money. Before making a decision that could set back your broader wealth goals, have a conversation with your Baird Financial Advisor – you might have other liquidity options that could keep your retirement funds intact.

Exceptions to the 10% Penalty Rule

IRAs offer several exceptions to the 10% penalty rule beyond your age. For example, you are allowed to withdraw up to $5,000 from an IRA for qualified birth or adoption expenses, and qualified individuals who suffer financial losses from a federally declared disaster can withdraw up to $22,000 without penalty. There are other penalty exceptions too, from buying your first home to higher education – your Baird Financial Advisor can walk you through your withdrawal options, and explore other liquidity strategies.

When You Are Required to Withdraw From an IRA

When you reach age 73, you will be required to take distributions from a traditional IRA, called required minimum distributions. If you reach this age but put off taking your distribution, the amount not withdrawn may be subject to a tax of 25%. (If you correct the missing RMD within two years, the tax drops to 10%.) If you have a Roth IRA, RMDs are not required. Below is an illustration of an optimized IRA withdrawal versus the impact of an early withdrawal:

IRA Withdrawals: Make the Most of Your Savings

The Long-Term Impact of an IRA Withdrawal

In addition to its more immediate tax ramifications, IRA distributions can have an impact on your longer-term wealth goals. For example, withdrawals can affect your Medicare premiums: The distribution (which is treated as taxable income) increases your modified adjusted gross income, and if your MAGI exceeds certain thresholds, you may be subject to an extra charge on your Medicare Part B and Part D premiums called IRMAA. The income from your IRA can also mean more of your Social Security will be taxed. So even if an IRA withdrawal solves for an immediate need, be aware that you might be inadvertently creating a new headache down the road.

Timing Is Everything

A good rule of thumb is to let your IRA compound until you must begin to draw from it so you don’t lose the savings momentum you’ve gained, and you can use it for those relaxing days ahead. Your Baird Financial Advisor can help you strategically review your IRA and other financial assets to ensure you’re optimizing your retirement savings. They can also help you tackle any financial challenges that you may consider using your IRA for – and what you can do instead of tapping this invaluable resource.