If a taxpayer separated from service and rolled over a 401(k) to an IRA, what is the impact of withdrawing funds from the IRA?

Withdrawing funds from an IRA after rolling over a 401(k) can have tax implications, especially if done before reaching the age of 59½. When a taxpayer takes distributions from an IRA before this age, they typically face an early distribution penalty, specifically a 10% additional tax on the amount withdrawn. This rule is established to discourage premature access to retirement savings and encourages individuals to keep their funds invested for long-term growth.

The early distribution penalties apply unless specific exceptions are met, such as disability, certain medical expenses, or qualified higher education expenses among others. Therefore, the correct understanding is that unless one qualifies for these exceptions, any withdrawals made before age 59½ will indeed incur penalties.

In contrast, the other options present misconceptions about the rules governing IRS regulations concerning IRAs. Funds cannot be withdrawn tax-free at any age, especially without qualification for exceptions, and not all withdrawals under $10,000 are penalty-free as the penalties revolve around age and circumstances rather than a specific dollar amount. Lastly, funds withdrawn from an IRA are treated as ordinary income for tax purposes, not as capital gains; thus, they are not subject to a lower tax rate associated with capital gains.