IRA Withdrawals and Penalties

What happens if I withdraw early?
If you withdraw money early from a Traditional, SEP or SIMPLE IRA, you owe a penalty tax equal to 10% of the withdrawal (see the next question for exceptions to this rule). Yikes! Ten percent! That's just handing a chunk of money that is rightfully yours over to the government. Don't you think we give them enough already!?!? Again, we can't state this enough, don't withdraw from your IRA early unless it is an absolute emergency.

If you withdraw early from a Roth IRA, the amount you withdraw is taxed as if it is regular income. That means that by withdrawing early from a Roth IRA, you pay income tax twice on the amount withdrawn. Nobody wants that!

Are there exceptions to early withdrawal rules?
Yes. You can withdraw early and without penalty from your Traditional, Roth, SEP or SIMPLE IRA if …

• … you are buying your first home (up to $10,000).
• … you are paying for qualified education expenses.
• … you are paying for medical expenses not covered by your insurance (up to the difference between those non-covered expenses and 7.5% of your AGI).
• … you have become disabled and have been unemployed for more than 12 weeks.
• … you are the beneficiary of a deceased individual's IRA and you have not rolled over that IRA to your own IRA.
• … the IRS withdraws money because of a levy.
• … you are forced to take out Substantially Equal Periodic Payments for everyday expenses (consult with your financial advisor to address the complex details).
• … you are a qualified military reservist called to active duty (if you are called to military duty, consult with your financial advisor to ensure you qualify for this exception).

Are there penalties for contributing too much to an IRA?
Because contributions to Traditional, SEP and SIMPLE IRAs are taxed on the front end, the IRS will not let you over-contribute to your IRA.

You can, however, over-contribute to a Roth IRA. If you do so and realize it before your tax returns are due, you can withdraw the excess money and not be penalized. If you fail to withdraw the excess money, you will be hit with an excise tax on the additional contributions. If you over-contribute in a particular year, however, you can avoid a penalty by contributing less the following year, assuming the excess contribution of the first year is less than or equal to the difference between the amount you contribute in the second year and the contribution limit for that year.

Whew, that was a mouthful. In other words, if you over-contribute by $1,000 in 2008, but contribute $1,000 less than the limit in 2009, you are in the clear.