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Structuring IRA Distributions To Prevent Penalties - Safe Harbor Planning: Some Helpful Ways
IRA distribution rules are a mine field. One incorrect move and you can find yourself faced with high taxes and penalties that can wipe out years of savings and investment. Complicating issues is the Darwinian evolution of IRAs that have taken place since the first IRA was launched in '74 with the enactment of the Worker Retirement Income Security Act (ERISA ). Since '74, IRA policy have changed dramatically and legislation was enacted to rigorously punish those who do not follow the rules, to the letter of the regulation. IRAs come in various flavors but, for reasons of this article we'll focus on the two main types of IRAs: Traditional IRAs and Roth IRAs.
Approaches 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 matter of a 10 percent penalty on the taxable quantity received in a distribution. There're particular IRA distribution rules that can be used to avoid the imposition of this early withdrawal penalty.
1. Using IRA Funds to Buy or Build Your First House - As much as $10,000 might be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, build or rebuild a first house for yourself, your spouse, you or your spouse's child, you or your spouse's grandchild or you or your wife's parent or ancestor.
2. Using IRA Funds for Medicinal Bills - Penalty-free early distributions can be made if the funds are used to pay unreimbursed medical bills which exceed 7.5 percent of your adjusted gross earnings. There's no obligation to itemize deductions to qualify for this exception.
3. Using IRA Money for College Expenses - Traditional IRAs can also be tapped to aid fund academy expenses; however, the taxable amount of the distributions from these IRAs shall 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 Contributions withdrawn are not matter of the ten percent penalty and there is no RMD with Roth IRAs. So as for Roth IRA earnings distributions to be tax-free, the account should have been opened for 5 years and the distributions should be made after reaching age 59 1/2. If you meet the five-year rule but not the 59 1/2 year rule, distributions in excess of your contributions might be taxable and subject to a ten percent penalty.
1. No RMD - With Roth IRAs, there's 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, during the lifetime of the owner, permitting a larger legacy for their beneficiaries.
2. Zero Percent Effective Tax Rate - Qualified distributions from Roth IRAs aren't subject to income tax...ever. This means you are unaffected by future tax increases as your effective tax rate is constantly 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 deferred 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, this kind of contributions can be a tax-free future funding source for your child's academy expenses.
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