Tennessee Insurance Practice Exam

What is the penalty tax applied to premature distributions from an IRA?

1. 5%

2. 10%

3. 15%

4. 20%

The correct answer is: 10%

The penalty tax applied to premature distributions from an Individual Retirement Account (IRA) is 10%. This is in accordance with IRS rules, which state that if you withdraw money from your IRA before reaching the age of 59½, you generally must pay a penalty tax based on the amount withdrawn. The rationale behind this rule is to discourage individuals from using their retirement savings for expenses before they reach retirement age, ensuring that these funds are preserved for their intended purpose. In certain situations, there are exceptions to this penalty, such as for first-time home purchases, certain educational expenses, or medical expenses, but the standard penalty for early withdrawal remains at 10%. This 10% tax applies to the amount of the distribution that is subject to income tax, which typically includes any amount that has not already been taxed, such as earnings on contributions. This important tax structure incentivizes individuals to keep their retirement funds intact until they are closer to retirement age.