What Is the Penalty for Cashing Out an IRA Certificate of Deposit?

by Michael Keenan

One of the available investments for money in your individual retirement arrangement is a certificate of deposit. Though it usually won't offer the same return as higher risk investments like mutual funds and stocks, it does offer a fixed rate of return and protection against loss. However, if you take an early withdrawal, you could face penalties from both the bank and the Internal Revenue Service.

Tax Penalties

If you're taking a qualified withdrawal from your IRA, you don't have to worry about any tax penalties on your withdrawal. If you're withdrawing from a CD in a traditional IRA, you must be at least 59 1/2 years old. If you're withdrawing from a CD in a Roth IRA, you must be 59 1/2, permanently disabled or taking out up to $10,000 for a first home, and your Roth IRA must be five years old. If you're not taking a qualified distribution, a 10 percent early withdrawal penalty applies to the taxable portion of your withdrawal unless an exception applies.

Taxable Early Distributions

Unless you've made nondeductible contributions to your traditional IRA, you pay income taxes on the entire distribution. If you have, your early withdrawal is prorated based on the percentage of nondeductible contributions in your account. For example, if your IRA consists of 35 percent nondeductible contributions, 35 percent of your withdrawal is tax-free and not hit with the penalty. Roth IRA early withdrawals let you take out all your contributions tax-free and penalty-free first. Only when you start taking out earnings will you pay the early withdrawal penalty.

Bank Penalties

Even if you don't owe a penalty to the IRS, you might have to pay a penalty to the bank if you're withdrawing before your CD matures. Just because your CD is in an IRA doesn't mean you can take out your money whenever you want. Instead, you generally pay three- to six-months of income as a penalty when you cash it out early, though the penalties vary from bank to bank.

Exceptions

In some cases, you might not have to pay either the early withdrawal penalty to the IRS or the bank. IRS penalty exceptions include higher education expenses, medical insurance premiums while unemployed, or qualified reservist distributions. If you're taking the distributions from an inherited IRA, you also avoid the IRS penalty and may also avoid the bank penalties, too.

About the Author

Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."

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