Traditional IRAs which I wrote about a few days ago are good for supplementing ones retirement, providing current tax deductions, and growing tax-deferred until retirement. However, when someone wants to use the money for retirement or other needs they should be conscious of the rules and limitations to avoid tax penalties. Let me say at the outset that planning for IRA distributions can be tricky so obtaining advice from a qualified financial expert would be a good idea. Roth IRA withdrawals work a little different, and covered them in a separate article.
If the owner wishes to withdraw money from their traditional tax-deductible IRA, all of the monies received are taxed at income tax rates, unless they make a special arrangement to donate them to a qualify charity. If they pull any funds out of the IRA account before their age of 59½ they will have to pay an additional 10% tax penalty, there are exceptions and I will cover them in a moment).
Money can be left in the IRA, so the owner is not forced to take it out, but they must begin making ‘Required Minimum Distributions (RMD)’ by April 1st of the year following the year they reach 70 ½. Failure to withdraw the RMD has a 50% tax ramification on the amount that should have been taken out. The RMD calculation considers all of money held in deductible IRAs, qualified plans, 403b and several other types of accounts.
The tax penalty for early withdrawal prior to the age of 59½ is punitive, encouraging people to leave the money in until they are older and retired. There are a few ways to avoid the penalty:
- First time home purchase
- Qualified education expenses
- Death or disability
- Unreimbursed medical expenses
- Health insurance if you’re unemployed
- 72t withdrawals
72t withdrawal regulations permit IRA holders to take out some or all of their accounts balances and avoid the 10% penalty if substantially equal periodic payments are withdrawn, over a minimum of 5 years or until age 591/2, whichever is longer. The rules are a little complicated and there are 3 different methods; the amortized method of level payments based on life expectancy and an assumed interest rate, similarly the annuitization method using the annuitant’s and beneficiary’s age and an interest rate, and the RMD method of dividing the account balance by the life expectancy each year.
