Regulations governing IRA withdrawals

Incorporating cash into an individual retirement account (IRA) is a smart move to enhance your retirement preparedness. Yet, to maximize your IRA benefits, you ought to be aware of the regulations relating to IRA distributions. Neglecting to adhere to these rules could result in unnecessary penalties, draining your savings unnecessarily. Here are some crucial distribution rules for IRAs:

What are required minimum distributions in IRAs?

Required minimum distributions (RMDs) represent mandatory withdrawals you must draw from all retirement accounts, apart from Roth IRAs, commencing in the year you turn 73. If you possess numerous traditional IRAs, you must compute the RMD for each individual account. Nonetheless, you can collect the aggregate RMD from a sole account or distribute it across various accounts.

The government mandates these withdrawals to guarantee it receives a portion of your savings since funds in traditional IRAs and 401(k)s are subject to taxation once withdrawn. Roth IRAs are exempt from RMDs due to tax-free withdrawals, given that contributions were made using after-tax income. The government bears no incentive to compel withdrawals from Roth IRAs as it does not profit from them.

The quantity you should withdraw annually depends on your IRA balance and age. Calculate your RMD by dividing your account balance by the distribution period for your age, as shown in this table.

For instance, if you have $100,000 in a traditional IRA and turn 73 in 2024, you divide your $100,000 account balance by the 26.5-year distribution period designated for 73-year-olds; your resulting RMD is approximately $3,773. This represents the minimum amount you must extract from your IRA this year, although you are free to withdraw more if you choose. Initially, retirees had to begin IRA distributions upon reaching 72 years old, but Secure Act 2.0 boosted the RMD age to 73.

Failing to withdraw the complete RMD by the end of the year triggers a 25% penalty on the amount you should have withdrawn. For example, if you withdrew only $1,000 from your traditional IRA this year, you'd incur a 25% penalty on the remaining $2,773 you should have extracted. You'd forfeit around $693 to the government – an amount far exceeding the income tax you would have paid had you withdrawn the full RMD. However, if you rectify your error within two years, the penalty could be reduced to 10%.

What is the IRA early withdrawal penalty?

The government generally imposes a 10% early withdrawal penalty when you acquire funds from your IRA before reaching age 59 1/2. Early withdrawals from traditional IRAs may be treated differently from withdrawals from Roth IRAs, given that contributions to traditional IRAs were made with taxable income.

There are ways to circumvent the early withdrawal penalty. These are elaborated upon in the section below.

When can I withdraw from my IRA without penalty?

You can withdraw from your IRA penalty-free under certain conditions:

You're age 59 1/2 or older: Once you reach 59 1/2, withdrawals are no longer considered early, and you won't incur a penalty, although taxes will still apply to traditional IRA distributions.
You're withdrawing contributions only: This rule is only applicable to Roth IRAs, where contributions have already been taxed. You can withdraw these contributions tax- and penalty-free at any time. Penalties arise only if you withdraw earnings early.
You're inheriting an IRA from a deceased person: Inherited IRAs come with their own distribution regulations, permitting those under 59 1/2 to make penalty-free withdrawals.
You have become permanently disabled: The government allows penalty-free distributions to any IRA owner who becomes severely and permanently disabled.
You're using the funds to pay for higher education: Using your IRA funds to cover higher education expenses, such as college tuition, qualifies you for penalty-free distributions.
You take substantially equal periodic payments (SEPPs): If you receive equal payments annually until you reach 59 1/2 or for five years, whichever is longer, then you can withdraw money from your IRA penalty-free, irrespective of your age.
You're using the funds to purchase your first home: If you withdraw funds from your IRA to purchase your first home, the first $10,000 in profits is exempt from the early withdrawal penalty.
You have large, unreimbursed medical expenses: If you incur substantial, uninsured medical expenses exceeding 7.5% of your adjusted gross income (AGI) in 2024 or 2025, you can withdraw IRA funds to cover these costs without paying penalties.
You're using the funds to pay health insurance premiums: If you are unemployed and paying for your own health insurance, you can withdraw the corresponding funds from your IRA without incurring the early withdrawal penalty.

These rules may change from year to year. For instance, in previous years, medical expense exemptions started at 10% instead of 7.5%. If you're younger than 59 1/2, always verify that you meet an exception to the early withdrawal penalty before withdrawing funds from your account.

Another thing worth noting: Even if you're eligible for the exemption from penalties, there might still be a significant price to pay when you withdraw funds early. When you do, you're effectively selling off your investments, thus reducing the amount of money left in your account to keep growing. Decreasing the size of your retirement savings today may make it harder to accrue enough for your future, so it's wise to explore alternative ways to cover your expenses without dipping into your IRA.

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This workaround can help high-income earners bypass the Roth IRA income ceiling. Be sure to check out our disclosure policy.

Although required minimum distributions (RMDs) are mandatory for individuals aged 73 with traditional IRAs, Roth IRAs are exempt due to tax-free withdrawals. Neglecting to withdraw the complete RMD by the end of the year results in a 25% penalty. However, in the case of Roth IRAs, withdrawals of contributions are tax- and penalty-free at any age.