Withdrawing Early From Your IRA? Here's Why That's a Pricey Move.

Key Points

• If you take money out of your IRA early, you'll get hit with a hefty penalty.

• You also lose out on the returns any withdrawn funds would have generated in the future.

• You should try to avoid early withdrawals from your retirement accounts unless absolutely necessary.

• The $23,760 Social Security bonus most retirees completely overlook ›

When you put money into an IRA, that money is earmarked for your retirement. The government provides tax incentives to make this account a powerful savings tool. The idea is invest the funds in your IRA wisely and let the balance grow for decades until you reach retirement age.

That's not always what happens, though. There may come a time when you are tempted to withdraw funds from your IRA early to use for other pressing expenses. While it may be tempting to do that when you need the funds and have the cash just sitting there in your retirement account, the reality is this can be a very costly mistake.

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Here's why early withdrawals from your IRA are so pricey.

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An early withdrawal from your IRA will come at a huge cost

Because you get a tax break when you make IRA contributions, the IRS has rules regarding when you can withdraw funds from the account. Specifically, if you withdraw money from an IRA before age 59 1/2 and don't qualify for one of the limited exceptions, you will owe a 10% penalty on the withdrawn amount. On top of the early distribution penalty, you'll be taxed at your ordinary income tax rate as you would be regardless of when you withdraw the funds.

These taxes, including the penalty, can really eat away at the amount you end up getting from a withdrawal. Let's say you take $15,000 out of your IRA because you have an emergency home repair. You'd be taxed at your ordinary income tax rate, so if that rate was 22%, you'd pay $3,300 in taxes. On top of those taxes, you'd also be hit with the 10% penalty, another $1,500.

The total tax bill is $4,800, or nearly one-third of your $15,000 withdrawal. And worse, because the distribution counts as income, you might end up pushing yourself into a higher tax bracket and paying taxes at an even higher rate. If that were to occur, you'd keep even less of the funds you withdrew, and you'd end up owing even more to the IRS.

There are costs beyond the taxes

Paying a huge tax bill for an IRA withdrawal is bad enough, but there are additional costs that you have to think about as well. Specifically, you need to consider the opportunity cost that comes with not leaving that money invested. That can make the initial tax hit look downright small.

Going back to the above scenario, let's say you withdraw $15,000 from your IRA 20 years before retirement. If you're earning 10% average annual returns, the $15,000 -- had it been left in your account -- would eventually grow into about $101,000 thanks to compounding. In other words, the $10,200 you collect from the early withdrawal (net of taxes), could leave you with about $100,000 less in retirement unless you're able to quickly replenish those funds in another savings vehicle like a brokerage account. The IRS does not allow IRA account holders to return early withdrawals to the account, except in very limited circumstances.

You should think seriously about these costs before you take money from your retirement plan. Otherwise, you could be left with major regrets.

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