You can transfer your individual retirement account (IRA) to a savings account, but you may have to pay a penalty and income tax. Here’s what you need to know. When you have a big expense to cover, you might ask yourself about the money sitting in your IRA. Can you use that to fund a big vacation, pay for an emergency medical expense or buy a house? The answer is: Yes, for a fee. And the cost might make you change your mind. Here’s what you need to know.
A financial advisor can help you build a strong financial plan for reaching retirement.
How an IRA Works
First of all, it’s important to understand how an IRA works. IRA stands for “individual retirement account,” and it’s an extremely popular investment option. As of 2019, IRAs made up the largest asset pool in the U.S. retirement market—more than one-third of all retirement assets.
The “individual” part of IRA means that the account is fully yours, unlike for instance a 401(k) plan you enter into with your employer. Because you have total control, you can transfer your IRA balance to a savings account if you like. However, you will likely have to pay taxes and penalties on that money.
There are two basic types of IRAs: a traditional IRA and a Roth IRA. These two types are taxed differently and, because of that, incur different fees and penalties if you want to transfer the all or part of your IRA to a savings account.
IRA Early Withdrawal Penalties
Most traditional IRAs have penalties if you withdraw early—that is before you reach the age of 59 ½. If you withdraw from your traditional IRA before that age, the IRS will charge income tax on the total amount withdrawn, as well as a 10% penalty. There are some exceptions, which include:
- Permanent disability
- Qualified higher education expenses
- Qualified first-time homebuyers
- Unreimbursed medical expenses
Even these exceptions have a lot of fine print and qualifying factors. So it’s important to make sure you fully understand the IRS’ rules before you make any moves.
A Roth IRA is taxed differently and thus has different tax outcomes if you decide to transfer the balance to a savings account. While traditional IRAs tax the money when you withdraw it, Roth IRAs tax the money when you deposit it. Thus, you won’t need to pay income tax on a Roth IRA withdrawal like you would with a traditional IRA withdrawal. That said, most early withdrawals from Roth IRAs incur a 10% tax penalty as well as taxes on any interest or dividends that have accrued.
It’s important to note that none of this applies if you’re transferring your IRA to another retirement vehicle. You should be able to rollover your IRA to another retirement plan or IRA without triggering any fees or taxes.
How to Make the Transfer
The actual transfer is the easy part. You can call or visit the financial institution where you hold your IRA and tell them you’d like to liquidate your account. These days it’s likely you can complete some or all of the process online. You’ll have to fill out some paperwork verifying where you’d like the money sent, so have your account numbers on hand.
The difficult part is understanding all of the tax ramifications as well as how this will impact your retirement. To make sure you’re making the right decision and fully grasp the fine print, you should consider talking to a financial advisor who can carefully analyze your individual situation.
If you’re panicking about bankruptcy emptying out your retirement savings or creditors getting their hands on your money, it’s important to know over $1 million of your IRA is protected from bankruptcy claims in most scenarios. Make sure you fully understand the effects an early withdrawal will have on your tax bill and your retirement plans before you make a hasty decision.
The Long-Term Impacts of Early Withdrawal
There might be situations in which taking money from your IRA early is a good financial decision. But in most cases, you should stick to your investment strategy. IRA accounts are important retirement tools because they allow you to save money while earning interest and dividends and getting tax advantages.
Rather than being taxed at the higher rates that other kinds of investments might incur, traditional IRA contributions are tax-deductible. And when you withdraw in retirement, that money is taxed as income.
Roth IRA accounts are not tax-deductible but when you withdraw from them in retirement, you won’t pay taxes. When you withdraw from your IRA early, the penalties often negate any dividends that your money might have earned. And it can destroy the tax advantages of these accounts.
That’s not the only negative effect that an early withdrawal can have. Retirement accounts are effective saving tools in large part because of compound interest, where your money multiplies over time. When you take your money out of the account, even setting aside the fees and taxes you’ll owe, you miss out on the interest compounding in the years between now and your retirement, essentially generating more money for you by sitting there.
If you withdraw from your IRA and feel you’ve made a mistake, you have time to correct that mistake. You would have 60 days to make the change to be precise. If you re-deposit that money back into the IRA or into another qualified retirement account, you can avoid the taxes and penalties. And as a result, you can get right back to generating interest.
While an IRA is yours to move around as you wish, it can come with a large tax bill. And it can have a major impact on your retirement savings. Like most tax issues, this can get complicated quickly. If you want expert advice to help you understand how best to move forward, you can enlist a financial advisor to walk you through your options.
- Handling tax-advantaged accounts can be confusing. That’s where the insights and guidance of a financial advisor can be valuable. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you want to set up and plan your retirement goals, SmartAsset’s retirement calculator can help you figure out how much you will need to save to retire comfortably.
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