- You already know that money put into the traditional IRA account is taxed when you take the money out and the Roth is a tax-free distribution structure. However, you must make sure you meet normal eligibility requirements to prevent unwanted taxes and penalties. With a traditional IRA, if you aren't yet 59 1/2 year old, you pay an extra 10 percent in penalties on distributions. With a Roth IRA, you must be 59 1/2 and have owned the IRA for at least five years. If you don't meet these requirements, all earning are added to income and penalized 10 percent. Calculate how much is added to your income before cashing the entire account out.
- In many cases, needing the money is reason enough to close the IRA regardless of the tax implications. Some reasons work in your favor more than others. The IRS waives the 10 percent penalty if you use $10,000 of IRA funds when buying a first home. It also waives penalties if funds are used for college expenses. There are certain hardship distributions where exceptions are waived. If you already meet normal distribution eligibility, closing the IRA to buy a home, take a dream vacation or a new car are all viable reasons; the money is yours to spend as you wish.
- Don't close an IRA because you are disappointed with investment performance. Instead, talk to your IRA custodian or financial adviser about other investment options that better suit your expectations. If your custodian doesn't offer something you are interested in -- say a bank custodian doesn't offer stock investments found at a brokerage custodian -- perform a tax-free transfer of the money.
Another poor reason to close an IRA out is because you have reached normal distribution eligibility and you can. While there would be no immediate tax implication for taking the money out, the future tax implication is losing tax-free earnings on the money. If you took $100,000 out of the Roth and put it into a savings earning 2 percent annually, that $2,000 is taxable. - Each person's financial situation is different, composed of unique goals, risk tolerance and savings capabilities. Don't rely on what your neighbor or co-worker are doing with their retirement funds to make your choices. Speak with tax advisers, financial representatives and estate planners to ensure you are making the best choice for your long-term objectives.
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