What is a ‘Withdrawal’
A withdrawal involves removing funds from a bank account, savings plan, pension or trust. In some cases, conditions must be met to withdraw funds without penalization, and penalization for early withdrawal usually arises when a clause in an investment contract is broken.
A withdrawal can be carried out over a period of time in fixed or variable amounts or in one lump sum and as a cash withdrawal or in-kind withdrawal. A cash withdrawal requires converting the holdings of an account, plan, pension or trust into cash, usually through a sale, while an in-kind withdrawal simply involves taking possession of assets without converting to cash.
BREAKING DOWN ‘Withdrawal’
Some retirement accounts, known as IRAs, have special rules that govern the timing and amounts of withdrawals. As an example, beneficiaries must start taking the required minimum distribution (RMD), or withdrawal, from a traditional IRA by age 70 1/2. Otherwise, the person who owns the account has a penalty assessed equal to 50% of the RMD. On the other hand, an account owner must refrain from withdrawing funds until at least age 59 1/2 or the Internal Revenue Service takes 10% of the withdrawal amount in a penalty. Financial institutions calculate the RMD based on the owner’s age, the account balance and other factors.
Statistics Regarding IRAs
In 2013, the IRS compiled statistics about IRAs and people who withdraw money early. During the 2013 tax year, more than 690,000 people paid penalties for early withdrawals, which is much lower than the 1.2 million in 2009. The amount paid in penalties dropped from $456 million to $221 million over that same period. People earning between $50,000 and $75,000, and then $100,000 to $200,000, made the most early withdrawals from IRAs. Despite these huge numbers, retirement accounts are not the only way for investors to earn money on withdrawals at a later time.
Certificates of Deposit
Banks typically offer certificates of deposit as a way for investors to earn interest. CDs draw higher interest rates than traditional savings accounts, but that’s because the money stays in the bank’s possession for a minimum amount of time. CDs mature after a set amount of time, and then someone can withdraw payments from the account, including any interest accrued during the time period.
In 2015, penalties for early withdrawals from CDs were steep. If someone withdrew early from a one-year CD, the average penalty was six months of interest. For a five-year CD, the typical penalty was 12 months’ interest. If someone withdrew money early from a three-month CD, the penalty included the entire three months of interest accrued in the account. Some penalties from banks dipped into taking a small percentage, such as 1 or 2%, of the principal amount invested in a CD. Banks assess early withdrawal penalties proportional to the time an investor must leave the money in the account, which means a longer-term CD gets a higher penalty.