Question

Jenn, age 35, has made deductible contributions to her traditional IRA over the past few years. When Jenn's, account balance was $30,000, Jenn received a distribution of the entire $30,000 balance of a traditional IRA. Jenn retained $5,000 of the distribution to help pay the taxes due from the distribution and Jenn immediately contributed the remaining $25,000 to a Roth IRA. What amount of tax and early distribution penalty is Jenn required to pay on the $30,000 distribution from the traditional IRA if Jenn's, marginal tax rate is 25 percent?

Answer 1

Traditional IRAs let individuals contribute pre-tax dollars to a retirement investment account, which can grow tax-deferred until retirement withdrawals occur (at age 59½ or later). As in current question, contributions to traditional IRAs are tax-deductible.
For example, If someone contributes $6,000 to their IRA, they can claim that amount as a deduction on their income tax return and the Internal Revenue Service (IRS) will not apply income tax to those earnings. However, when that individual withdraws money from the account during retirement, those withdrawals are taxed at their ordinary income tax rate.
Hence, in the given case, when Jenn withdraws the balance in IRA account to the extend of $ 30,000, she will be taxed for the entire withdrawal at her ordinary income tax rate; ie, 25%

Therefore, Tax payable on IRA withdrawn = $ 30,000 * 25% = $ 7,500.

Also, as we can see, Jenn has withdrawn the balance from IRA account at the age of 35 itself. This is a violation of the rule of withdrawal which is allowed only to be made at the time of retirement. (at age 59½ or later). Funds removed before full retirement eligibility incur a 10% penalty (of the amount withdrawn) and taxes, at standard income tax rates. There are exceptions to these penalties for certain situations. These include the following:

• You plan to use the distribution towards the purchase or rebuilding of a first home for yourself or a qualified family member (limited to $10,000 per lifetime).
• You become disabled before the distribution occurs.
• Your beneficiary receives the assets after your death.
• You use the assets for unreimbursed medical expenses.
• Your distribution is part of a SEPP program.
• You use the assets for higher-education expenses, or expenses incurred for having or adopting a child.
• You use the assets to pay for medical insurance after you lose your job.
• The assets are distributed as a result of an IRS levy.
• The amount distributed is a return on non-deductible contributions.
• You are in the military and called to active duty for more than 179 days.

Hence, in the given question, the reason for withdrawal is not specifically given and hencewe assume that the reason does not belong to any of the ones listed above. This will inturn lead to payment of penality for early withdrawal to the extend of 10% of the amount such withdrawn.

Therefore, Penality payable on IRA withdrawn early = $ 30,000 * 10% = $ 3,000.