Can I Close My Retirement Account? What to Know First

Retirement accounts offer tax advantages to help individuals save for their later years. While primarily intended for retirement, circumstances sometimes lead to early access. Understanding the implications of withdrawing from or “closing” a retirement account before retirement age is important due to specific rules and financial consequences.

Types of Retirement Accounts and Basic Withdrawal Rules

Many different types of retirement accounts exist, each with distinct contribution and withdrawal rules. A Traditional Individual Retirement Account (IRA) generally allows pre-tax contributions, which may be tax-deductible, and earnings grow tax-deferred until withdrawal. A Roth IRA is funded with after-tax contributions, allowing qualified distributions in retirement to be entirely tax-free.

Employer-sponsored plans like 401(k)s, 403(b)s (for public schools and tax-exempt organizations), and 457 plans (for government employees) often feature pre-tax contributions and tax-deferred growth, similar to a Traditional IRA. Some also offer a Roth option.

Qualified distributions from most retirement accounts (Traditional IRAs, 401(k)s, 403(b)s, and 457(b) plans) can be taken without a 10% early withdrawal penalty once the account holder reaches age 59½. For Roth IRAs, qualified distributions are also tax-free and penalty-free if the account has been open for at least five years and the account holder is age 59½ or meets another qualifying condition.

Required Minimum Distributions (RMDs) generally apply to most tax-advantaged retirement accounts, including Traditional IRAs, 401(k)s, and 403(b)s, once the account holder reaches age 73. These rules mandate annual withdrawals to ensure funds are distributed during their lifetime. Failing to take an RMD can result in a 25% penalty, which can be reduced to 10% if corrected promptly. Roth IRAs do not have RMDs for the original owner.

Tax and Penalty Implications of Early Account Closure

Early withdrawals from retirement accounts before age 59½ typically incur financial consequences. Distributions from pre-tax accounts (Traditional IRAs, 401(k)s, 403(b)s) are generally added to gross income and taxed at ordinary rates. For Roth IRAs, non-qualified distributions of earnings can be subject to both income tax and penalties.

In addition to ordinary income tax, early distributions from most retirement accounts are usually subject to an additional 10% early withdrawal penalty. This penalty applies to the taxable portion and discourages using retirement savings for non-retirement purposes. For example, a $10,000 withdrawal from a Traditional IRA before age 59½ would generally owe income tax on the $10,000, plus an additional $1,000 penalty.

The Internal Revenue Service (IRS) provides several exceptions to the 10% early withdrawal penalty, though distributions may still be subject to ordinary income tax. These include distributions for total and permanent disability, unreimbursed medical expenses exceeding 7.5% of adjusted gross income, qualified higher education expenses, or a qualified first-time home purchase (limited to $10,000).

Other penalty exemptions include distributions received as substantially equal periodic payments (SEPPs) over a lifetime or life expectancy. Funds distributed due to death of the account holder, or to an alternate payee under a Qualified Domestic Relations Order (QDRO), are also not subject to the 10% penalty.

Alternatives to Full Account Closure

Before closing an account, individuals have several options to manage or move retirement funds without immediate tax and penalty consequences. One common method is a rollover, moving funds from one retirement account to another eligible account, preserving their tax-deferred or tax-free status. A direct rollover transfers funds directly from one trustee to another, avoiding temporary distribution to the account holder.

An indirect rollover, also known as a 60-day rollover, involves the account holder receiving funds directly before depositing them into a new retirement account within 60 days. If not redeposited within this 60-day window, the distribution becomes taxable and potentially subject to the 10% early withdrawal penalty if the individual is under age 59½. Only one indirect rollover is permitted per 12-month period across all IRAs, though this limitation does not apply to rollovers from employer plans to IRAs or from one employer plan to another.

Another alternative is a direct transfer, or trustee-to-trustee transfer, where funds move directly between financial institutions without the account holder taking possession. This process has no tax implications and is not subject to the 60-day rule or the one-per-year rollover limit. Direct transfers are commonly used when moving an IRA from one custodian to another.

A Roth conversion moves funds from a pre-tax retirement account (Traditional IRA or 401(k)) into a Roth IRA. The converted amount is generally taxable as ordinary income because the funds shift from a tax-deferred to a tax-free growth environment. The conversion itself is not subject to the 10% early withdrawal penalty, regardless of age. Once converted, funds must remain in the Roth IRA for at least five years before earnings can be withdrawn tax-free and penalty-free, even if the account holder is over age 59½.

Steps for Closing a Retirement Account

Closing a retirement account to receive a distribution involves procedural steps with the account provider. First, contact the financial institution or plan administrator that holds the retirement account. This can be done via phone, online portal, or written request.

Account holders will complete specific forms, such as a distribution request form, provided by the institution. This form asks for details like account number, personal identification, and desired distribution method (e.g., lump sum, partial withdrawal). The forms may also include options for federal and state income tax withholding, allowing the account holder to elect a percentage of the distribution to be withheld for taxes.

Once completed, submit the forms to the provider through their specified channels (mailing, online upload, or in-person delivery). After submission, the financial institution will process the request, which can take several business days to a few weeks. The account holder should receive confirmation once the account is closed and the distribution processed.

Following the distribution, the financial institution will issue Form 1099-R in January of the following calendar year. This form reports the distribution amount and any taxes withheld to both the account holder and the IRS. The information on Form 1099-R is necessary for accurately reporting the distribution on the account holder’s income tax return.