Can someone explain how IRA early withdrawal penalties are calculated?
January 24, 2013 9:44 AM Subscribe
Everywhere mentions a 10% penalty, but nobody says whether this is pre or post tax, or whether it's added to your existing tax burden, or how these taxes actually get paid, etc.
posted by tylerkaraszewski to Work & Money (7 answers total) 1 user marked this as a favorite
I can imagine several possible scenarios here. For instance, assume you have a traditional IRA with a value of $100,000. Also presume you are in a very side 25% tax bracket so that the whole withdrawal would be taxed at 25% if it were simply classified as income (just to make calculations simple).
Do you pay a 10% penalty and then pay income tax on the rest? I.e.:
100,000 * .9 = 90,000 * .75 = $67,500 remaining.
Do you pay income tax on the whole thing and then pay a 10 penalty on the original amount as well?
100,000 * .75 = 75,000 - (100,000 * .1) = $65,000 remaining.
Do you pay income tax on the whole thing and then pay a 10% penalty on what's remaining?
100,000 * .75 = 75,000 - (75,000 * .1) = $67,500 remaining.
Do you pay an additional 10% in income tax?
100,000 * (1 - (.75 + .1)) = $65,000 remaining.
Clearly, some of these situations turn out equivalent, but there are still at least two possible ways to calculate this, and this information is perplexingly difficult to find online. What does the "10% penalty" actually apply to?
Also, if you do this, who is responsible for paying the taxes? Will the IRA administrator take out estimated taxes and pay the IRS at the time of distribution? Will they give you the entire withdrawal and leave it up to the person making the withdrawal to calculate the appropriate taxes at the end of the year? If the latter, do you need to pay some sort of special payment to avoid an under-witholding penalty at the end of the year?