Early Withdrawal

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Question: What happens if you withdrawal early from a Roth IRA?

A traditional IRA or 401k seems easy to understand. If you take out money early, you pay a hefty tax.

Answer: If one withdraws money form ANY qualified retirement account before 59 1/2 or official retirement, there is a 10% penalty on the amount withdrawn, plus ordinary income tax on non Roth income.

After 5 years, you can withdraw up to 100% of the PRINCIPLE (the cash you put in the account) in a ROTH IRA ONLY at anytime with NO penalty. Best to try and keep it in if all possible – it should be geared for retirement only.

The INTEREST or any GAINS MUST stay in the ROTH account until at least 59 1/2 or suffer IRS 10% tax penalty on the gains only, plus pay ordinary income tax on the entire gain that was withdrawn.

Exception:
$10,000 may be taken out to buy a first home with no penalty. Certain health care, and high education expenses are also exempt from penalties.

Other exemptions and taxes
Additional Tax on Early Distributions

http://www.irs.gov/publications/p590/ch02.html#en_US_publink1000231064

How much will my 401K cashout tax be?

http://answers.yahoo.com/question/index?qid=20090303111950AAijAaE&r=w&show_comments=true&pa=FZB6NWHjDG3N56z6v_2wXVTV6igbwQuehdgfQCGq2KUvXhjrBd.HQA–&paid=add_comment#openions

Which is better?

In my view, the ROTH offers greater long term flexibility by allowing access to your principle after 5 years where the Traditional IRA does not.

Next, when you think 10, 20, 30+ years of growth and NOT having to pay ANY taxes on a ROTH at retirement (min age: 59 1/2), the NET growth potential of the ROTH is effectively greater because the Traditional IRA will be 100% subject to income tax in the future at whatever tax rates Congress decides.

Example:
Value of IRA in 20 years: $100,000
Value of ROTH IRA in 20 years: $100,000
Federal Tax bracket in 20 years: 20% (hypothetical)

If take out all money at once: (normally some funds taken out each year not before 59 1/2 and not later than age 70 1/2 – minimum withdraws required by 70 1/2 – determined by a life expectancy formula – “actuary table.” – don’t need to know all this now, because the formula will change in the future.)

Federal Tax on IRA: $20,000 (20% tax bracket)
Federal Tax on ROTH: $0.00 (any tax bracket)

State Tax on IRA: (depends on your state)
State Tax on ROTH: 0%

Best:
Max out ROTH IRA each year. Even if you quality for the little tax deduction on the Traditional IRA with your current taxes, it will cost you more money in terms of paying more taxes in the future when the money comes out. ROTH IRA avoids the government from taking your money again in the future.

Roth IRA

http://en.wikipedia.org/wiki/Roth_IRA

Roth IRAs (IRS.gov)

http://www.irs.gov/publications/p590/ch02.html

The aforementioned should not be deemed as tax, legal or financial advice, please see profile for full disclaimers.

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401k Withdrawal Rules – 3 Things You Need to Know