Sometimes during or after a divorce, a person with a need for additional cash will consider withdrawing money out of a traditional IRA. This is nearly always a bad idea because the withdrawal will be treated as income for state and federal income tax purposes. It also will likely trigger 10% early withdrawal penalty by the IRS.
If you live in California, your marginal state income tax rate is probably in the 8-10% range.
Your federal marginal income tax rate is probably in the 22-24% range.
So, before the penalty is factored in, you will have to pay about one-third of the amount withdrawn in state and federal income taxes.
The penalty is an additional 10% of the amount withdrawn. It is payable on withdrawals before the age of 59 and 1/2. So factoring in the penalty, in total, 40% or more of the amount withdrawn will need to be paid to the government.
How to Avoid the Early Withdrawal Penalty
The best way to avoid the penalty is of course not to do the withdrawal at all. The next best way is to do the withdrawal after age 59 and ½.
The IRS does give some ways to avoid the early withdrawal penalty. Unfortunately, for most people, they are usually not helpful. But here they are:
- fund part of the purchase of a first home
- pay for college costs
- pay for large medical expenses
- buy health insurance after being laid off
- pay birth of adoption costs
- cover the cost of military service
- pay disability expenses
- use the money to set up an annuity
Also, here are some ways to get cash from retirement accounts other than from a traditional IRA. Each will avoid the early withdrawal penalty:
- withdraw the funds from a Roth IRA or
- take a distribution from an inherited IRA
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