What Happens When You Take an Early IRA Withdrawal?

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The quick answer? It depends on why you’re removing that money. 

It’s important to save for retirement, because without a nest egg of your own, you might struggle financially later in life. Case in point: The average older American on Social Security today receives a benefit of $1,827 a month. That’s an annual income of around $22,000, which generally won’t make for a very comfortable retirement.

If you want to set yourself up for a stable retirement, then it’s a good idea to contribute money steadily to an IRA account. But you may reach a point where you want to tap your IRA ahead of retirement.

Generally speaking, you’ll be penalized to the tune of 10% of the sum you withdraw for removing funds from an IRA before reaching age 59 1/2. But there are also some exceptions to this rule you should know about.

The circumstances of your early withdrawal matter

It might seem unfair that you’d be penalized for removing money from your IRA prior to age 59 1/2. After all, that money is yours — and you no doubt worked hard to save it.

But remember, when you fund a traditional IRA, you get a tax break on the money you contribute. A $3,000 traditional IRA contribution this year, for example, will exempt $3,000 of your income from taxes. Because the IRS gives you that break, it wants you to use your IRA funds for their intended purposes — retirement. And it doesn’t tend to take kindly to early withdrawals.

There are, however, a few exceptions. For one thing, if you’re a first-time home buyer, you’re allowed to remove up to $10,000 from your IRA to purchase a home. And if you and your spouse are both first-time home buyers, that $10,000 limit applies to each of you individually, giving you the option to remove up to $20,000 in total and use those funds for a down payment.

The second exception is that you’re allowed to remove funds from an IRA early without penalty to pay for college. And to be clear, that holds true whether you’re paying your own college tuition, or whether you’re paying it for a spouse or child.

There are also certain other limited exceptions. You can usually, for example, take an early IRA withdrawal without penalty to cover medical expenses that exceed 10% of your adjusted gross income.

But otherwise, if you tap your IRA prior to age 59 ½, you should expect to be penalized. This holds true even if you’re raiding your IRA to cover something important, like a home repair.

Should you tap your IRA ahead of retirement?

If you’re looking to do something like pay for college or buy a home, it’s easy to see why taking an IRA withdrawal might be tempting. But remember, every dollar you remove from your IRA is money you won’t have available in retirement, when you might need it the most. So generally speaking, it’s best to leave the money in your IRA alone and save for things like a home purchase or college separately.

Keep in mind, too, that when you remove money from your IRA ahead of retirement, you lose out on more than just that principal withdrawal. That’s because IRAs can be invested, and over time, your money can grow.

So let’s say your IRA normally delivers an average yearly 7% return. If you take a $10,000 withdrawal to buy a home at age 35, and you don’t retire until age 65, you’ll end up with $76,000 less for retirement when you factor in lost investment gains. And so while raiding your IRA might seem like a good solution when you need to pay for a home or education, doing so could be really detrimental to your retirement.

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