IRA withdrawal rules: What to know

This article was fact-checked by our editors and CPA Janet Murphy, senior product specialist with Credit Karma.

If you’re struggling financially and have some money set aside for retirement in a traditional IRA, you may be wondering if you can use those funds to ease some of the hardship you’re experiencing.

You can take money out of your traditional IRA before you retire for any reason — it doesn’t have to be a hardship. But you may need to pay federal income tax on the amount you withdraw.

Typically, if you’re younger than 59½, your withdrawal will need to meet certain conditions in order to avoid an additional 10% tax on the funds you take out of your IRA. But during the pandemic, a coronavirus-related distribution is one of the conditions that would allow you to avoid the early-withdrawal penalty.

• What are IRA rules?
• When are IRA withdrawals taxed?
• How can I avoid the 10% early-withdrawal penalty?
• What are required minimum distributions?
• How has COVID-19 affected IRA withdrawal rules?

What are IRA rules?

An individual retirement arrangement, or IRA, is usually made up of contributions that you (or an employer) put into the account, as well as interest and dividends the account earns on the investments you’ve made. There are multiple types of IRAs, but for this article we’ll focus on traditional IRAs.

If you (and your spouse, if married filing jointly) aren’t covered by a retirement plan through an employer, you can deduct the full amount you contribute to your traditional IRA — up to the IRA contribution limit — on your federal income tax return. If you or your spouse are covered by an employer retirement plan, your deduction may be limited based on your income.

The earnings in your IRA generally aren’t taxed until you withdraw them.

What is the IRA contribution limit for 2020?

For the 2020 tax year, you’re allowed to contribute a total of $6,000 to your IRA accounts, both traditional and Roth. The limit is $7,000 if you’re 50 or older.

When are IRA withdrawals taxed?

The rules for IRA withdrawals can be confusing. Whether you have to pay federal income tax and a penalty on withdrawals from a traditional IRA depends on certain situations, including the following:

• Your age when you make the withdrawal
• Whether you withdraw a contribution, earnings or both
• Whether you made contributions that were deductible
• When you make a withdrawal during the tax year

Remember that the money in your IRA comes from two sources — contributions and earnings. This is important because you generally don’t have to pay tax if you withdraw a contribution before the filing deadline (or the extension deadline, if you got an extension) for the tax year in which you made the contribution.

For example, say you contributed $5,000 to your IRA between Jan. 1 and Dec. 31, 2020. You could withdraw that same amount, tax free, right up until the filing deadline for your 2020 federal income taxes, which will likely be April 15, 2021.

Here’s why: If you made a nondeductible IRA contribution — one that you didn’t deduct on your federal income taxes — you can withdraw that amount tax free because you already paid tax on the money before you put it into the IRA.

Withdrawing earnings and gains is a bit different, because this is money the account made for you and it hasn’t been taxed yet. So when you withdraw the earnings and gains, you’ll need to pay tax on them.

IRA withdrawal rules are complex, so it’s possible to have a withdrawal (also known as a distribution) that’s only partially taxable. But when a distribution is taxable, it will be treated as regular income and subject to regular income taxes.

How can I avoid the 10% early-withdrawal penalty?

If you take money out of your traditional IRA before you’re age 59½, your distribution will be considered an early withdrawal. Besides being subject to federal income tax, your early withdrawal may also be subject to an additional 10% tax — unless it falls under one of several exceptions.

You can find a full list of exceptions on the IRS website, but here are a few to be aware of.

• The owner of the IRA dies.
• You become totally and permanently disabled.
• You withdraw money to pay for qualified higher-education expenses.
• You use up to $10,000 of your IRA money to buy your first home.
• You withdraw funds to cover a certain percentage of medical expenses that weren’t reimbursed or to pay health insurance premiums while you’re unemployed.

You’ll need to show the amount of your traditional IRA withdrawal on your 1040 tax return. You may also need to file Form 5329, which tells the IRS that your distribution was an early withdrawal and whether or not you have to pay an early-distribution penalty.

What are other types of individual retirement arrangements?

In addition to traditional IRAs, there are also Roth IRAs (qualified distributions may be tax free), SIMPLE IRAs (contributions come from employers and employees), and SEP IRAs (which can be for self-employed people).

What are required minimum distributions?

Retirement plans are meant to help you save money for your support when you’re no longer part of the workforce. You’re not allowed to keep money in your IRA forever, so you’ll have to start taking required minimum distributions, or RMDs, when you reach a certain age. Every tax year afterward, you’ll need to take your RMD by December 31.

The age for RMDs used to be 70½, but in 2019 the federal government changed it. The Setting Every Community Up for Retirement Enhancement Act, or SECURE Act, reset the RMD age to 72 going forward. But people who turned 70½ before Jan. 1, 2020, must still take RMDs.

This means people whose 70th birthday falls on July 1, 2019, or later won’t have to take RMDs until they turn 72.

How much is your required minimum distribution? You’ll need to calculate the amount. The IRS provides an IRA Required Minimum Distribution Worksheet to help.

Remember, the RMD is merely the minimum you must withdraw. You can take more than the minimum. You’ll have to include withdrawals in your taxable income, but you can exclude any part that was already taxed.

Note that for 2020, pandemic relief legislation waived RMDs for IRAs and certain other types of retirement plans.

How has COVID-19 affected IRA withdrawal rules?

If you’re struggling financially because of the coronavirus pandemic, you may be considering taking money out of your IRA. The Coronavirus Aid, Relief and Economic Security Act, or CARES Act, includes provisions to allow Americans financially affected by COVID-19 to use IRA funds for relief. Here are a few.

• Up to $100,000 in withdrawals made for coronavirus-related purposes won’t be subject to the 10% additional tax — even if you’re younger than 59½.
• You can take up to three years to pay the federal income tax due on the withdrawal.
• If you put the money back into your IRA or another eligible retirement plan within three years of making the withdrawal, your distribution won’t be taxed at all.

You may be eligible to take advantage of this relief if one of these situations applies to you.

• You, a spouse or a dependent have been diagnosed with COVID-19.
• You or your spouse were adversely affected financially by being quarantined, furloughed or laid off, or had your work hours or pay reduced because of COVID-19.
• You or your spouse couldn’t work because you had no one to care for your kids because of COVID-19.
• You or your spouse owned or operated a business that closed or reduced its operating hours because of COVID-19.

Bottom line

An IRA can be a great way to save money for retirement, but you generally shouldn’t view your retirement savings as a source of ready money before you retire. IRA withdrawal rules are specific, and early-withdrawal penalties are designed to encourage you to leave money in the account until your retirement years.

But once you do retire, you can’t leave the money in the account forever. You’ll need to take at least a minimum amount out of your IRA every year once you reach a certain age.

Relevant sources: IRS notice 2020-50: Guidance for Coronavirus-Related Distributions and Loans from Retirement Plans Under the CARES Act | IRS: IRA FAQs — Distributions (Withdrawals) | IRS: About Form 5329, Additional Tax on Qualified Plans | IRS Retirement Topics — Exception to Tax on Early Distributions | IRS: IRA FAQs — Contributions | IRS Retirement Topics — IRA Contribution Limits | IRS Publication 590-A (2019), Contributions to Individual Retirement Arrangements (IRAs) | IRS: Retirement Plan and IRA Required Minimum Distribution FAQs | IRS Retirement Topics — Required Minimum Distributions (RMDs) | IRS Publication 590-B (2019) Distributions from Individual Retirement Arrangements (IRAs)

A senior product specialist with Credit Karma, Janet Murphy is a CPA with more than a decade in the tax industry. She’s worked as a tax analyst, tax product development manager and tax accountant. She has accounting degrees and certifications from Clemson University and the U.S. Career Institute. You can find her on LinkedIn.