Traditional, Rollover and SEP IRA Distributions
- Traditional, Rollover and SEP IRA distributions are taxed as ordinary income according to federal and state income tax rates.
- Unless an exception applies, an IRA distribution is subject to a 10% penalty tax.
- If nondeductible IRA contributions were made in the past, part of the distribution is not taxable.
IRA Distribution Form
Penalty Tax Exceptions
When you are 59½ or older, your distribution is penalty-free.
Higher education expenses
Your distribution may be penalty-free for certain expenses (e.g. tuition, books, supplies) at certain colleges and other postsecondary institutions. The penalty exception can apply to expenses for you, your spouse, children or grandchildren.
First time home purchase
Up to $10,000 of your distribution may be penalty-free if used to buy, build or rebuild your first home. There is a lifetime limit of $10,000 for the penalty exception, and “first home” means that you have not owned a home in the prior two years. The funds must be used within 120 days after you receive them. The penalty exception can apply to a first home for you, your spouse, your or your spouse’s children and grandchildren, and your or your spouse’s parents. Note that the individual who must meet the definition of a first-time homebuyer is the person acquiring the home–not the IRA owner.
Your distribution may be penalty-free if used for expenses of the birth or adoption of a child. Penalty-free distributions are limited to $5,000 in aggregate across all IRAs and retirement accounts. The distribution must be made within one year after the birth or adoption date and can be repaid.
Your distribution may be penalty-free if used to pay health insurance premiums when all of these conditions are met:
– You lost your job;
– You received unemployment compensation for at least 12 consecutive weeks;
– Your distribution is taken in the same or following year that you receive unemployment compensation; and
– Your distribution is taken no later than 60 days after you are reemployed.
Unreimbursed medical expenses
Beginning in 2021, your distribution may be penalty-free on certain unreimbursed medical expenses that exceed 7.5% of your income if you’re under age 59½. The distribution must be made in the year that the expenses are paid.
Charlie is 50. His unreimbursed medical expenses are $6,000, his income is $40,000, and he takes an IRA distribution. The maximum amount that Charlie may consider as a penalty-free distribution is $3,000 ($6,000 – [7.5% x $40,000] = $3,000).
Your distribution may be penalty-free if you are a member of the military reserve; were called to active duty for at least 180 days (or for an indefinite time) after September 11, 2001; and the distribution was taken while you were called to active duty.
Substantially Equal Periodic Payments
Your distribution may be penalty-free if it is part of a series of Substantially Equal Periodic Payments (SEPP). SEPP distributions must occur annually and for five years or until you turn 59½, whichever is later. If distributions are modified, the 10% penalty tax, plus interest, is applied retroactively to all previous distributions.
Your distribution may be penalty-free if you are unable to engage in any substantial gainful activity. A physician must certify that your disability will be long-term; continuous; of an indefinite duration; and is expected to lead to death.
Your distribution is penalty-free if it occurs as a result of an IRS tax levy.
Your distribution is penalty-free if you inherited the IRA and the distribution is taken from the deceased’s IRA.
Determining the Non-Taxable Portion of a Distribution
If you have ever made non-deductible IRA contributions and have more than one IRA, you must aggregate all of your IRAs (e.g. Traditional, Rollover, SEP and SIMPLE) to calculate the taxable portion of your distribution. In other words, the IRS views you as having one big IRA, regardless of how many IRAs you own.
Many years ago, Jenny made a $2,000 non-deductible contribution to an IRA. Her other contributions were deductible. Today, she has three IRAs that total $10,000.
Jenny redeems $1,000. Since her non-deductible contribution makes up 20% of her total IRA balance, 20% of her $1,000 distribution (i.e. $200) is not taxable, regardless of which IRA is redeemed.
NOTE: This is a simplified example. Be sure to complete and attach IRS Form 8606 with your taxes.
Redemptions are reported on IRS Form 1099-R (“Distributions from IRAs”) which is mailed to you in January.