Structuring IRA Distributions To Prevent Penalties - Safe Harbor Planning: A Few Effective TechniquesIRA distribution rules are a mine field. One incorrect move and you can discover yourself faced with high taxes and penalties that could wipe out years of savings and investment. Complicating matters is the Darwinian evolution of IRAs that have taken place since the pioneer IRA was launched in 1974 with the enactment of the Worker Retirement Income Security Act (ERISA ). Since '74, IRA rules have changed dramatically and legislation was enacted to severely punish those who don't follow the rules, to the letter of the rule. IRAs come in several flavors but, for reasons of this article we'll focus on the two key types of IRAs: Traditional IRAs and Roth IRAs.
Methods 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 quantity received in a distribution. There are certain IRA distribution rules that could be used to avoid the burden of this early withdrawal penalty.
1. Using IRA Money to Buy or Build Your First Home - Up to $10,000 might be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, build or repair a first house for yourself, your spouse, you or your spouse's kid, you or your spouse's grandchild or you or your spouse's parent or ancestor.
2. Using IRA Money for Medical Expenses - Penalty-free early distributions can be made if the money are used to pay unreimbursed medicinal expenses which exceed 7.5 % of your adjusted gross income. There is no obligation to itemize deductions to be eligible for this exception.
3. Using IRA Money for School Expenses - Traditional IRAs can also be tapped to aid fund college costs; however, the taxable amount of the distributions from these IRAs will be subject to income tax in the year of the distribution.
Roth IRA distribution rules
Roth IRAs have unique rules with respect to distributions. Contributions withdrawn are not matter of the 10% penalty and there's no RMD with Roth IRAs.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 should 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 will be taxable and subject to a 10% 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. As a result, 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 are unaffected by future tax increases as your effective tax rate is always the same...zero.
3. Conversion Chances - Beginning after January 1, 2010 anybody, irrespective of their income level, may convert conventional 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 enough money set aside to do a 100% conversion you can do partial conversions.
4. University Costs - As Roth IRA contributions may be withdrawn, tax-free, penalty-free, at any time, such contributions can be a tax-free future funding source for your child's school expenses.
