Structuring IRA Distributions To Avoid Penalties – Secure Harbor Planning: A Few Useful Ways
IRA Distribution Rules are a mine field. One wrong move and you could discover yourself faced with high taxes and penalties that may wipe out years of savings and investment. Complicating matters is the Darwinian evolution of IRAs which have taken place since the pioneer IRA was introduced in 1974 with the enactment of the Employee Retirement Income Security Act (ERISA ). Since ’74, IRA rules have altered dramatically and legislation was enacted to rigorously punish those who don’t follow the policy, to the letter of the law. IRAs come in many flavors but, for reasons of this article we will focus on the 2 major forms of IRAs: Traditional IRAs and Roth IRAs.
Techniques for Minimizing Penalties on Early Distributions
Generally, any distribution from an IRA before you reach age 59 1/2 is considered an early distribution and is subject to a 10 percent penalty on the taxable amount received in a distribution. There are specific Roth IRA information that can be used to avoid the burden of this early withdrawal penalty.
1. Using IRA Money to Buy or Construct Your First House – As much as $10,000 might be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, build or rebuild a first home for yourself, your spouse, you or your spouse’s kid, you or your spouse’s grandchild or you or your wife’s parent or ancestor.
2. Using IRA Money for Medical Costs – Penalty-free early distributions could be made if the funds are used to pay unreimbursed medicinal expenses which exceed 7.5 % of your adjusted total earnings. There is no requirement to itemize deductions in order to be eligible for this exception.
3. Using IRA Funds for Academy Expenses – Conventional IRAs can also be tapped to aid fund university costs; however, the taxable amount of the distributions from these IRAs will be matter of income tax in the year of the distribution.
Roth IRAs have unique policy with respect to distributions. Contributions withdrawn are not subject to the 10% penalty and there is no RMD with Roth IRAs. In order for Roth IRA earnings distributions to be tax-free, the account should have been opened for five years and the distributions must be made after reaching age 59 1/2. If you meet the 5-year rule but not the 59 1/2 year regulation, distributions in excess of your contributions might be taxable and matter of a ten percent penalty.
1. No RMD – With Roth IRAs, there is no RMD at age 70 1/2. This means a Roth IRA operator is never needed to make a distribution out of their Roth IRA. Because of this, Roth IRAs can grow, untaxed, throughout the lifetime of the owner, allowing a larger legacy for their beneficiaries.
2. Zero Percent Effective Tax Rate – Qualified distributions from Roth IRAs are not subject to income tax…ever. This means you’re unaffected by future tax increases as your effective tax rate is always the same…zero.
3. Conversion Possibilities – Beginning after January 1, 2010 anybody, irrespective of their earnings level, may convert traditional IRAs into Roth IRAs. The tax on the taxable income for 2010 conversions can be delayed into 2011 and 2012. If you do not have sufficient money set aside to do a 100% conversion you can do partial conversions.
4. College Costs – As Roth IRA contributions might be withdrawn, tax-free, penalty-free, at any time, such contributions can be a tax-free future funding source for your child’s university expenses.
