Structuring IRA Distributions To Avoid Penalties - Secure Harbor Planning: A Few Useful Ways


IRA distribution rules are a mine field. One incorrect move and you could find yourself faced with high taxes and penalties which could wipe out years of savings and investment. Complicating issues 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 policy have altered dramatically and laws was enacted to severely punish those who do not follow the regulations, to the letter of the rule. IRAs come in a lot of flavors but, for reasons of this article we will focus on the 2 major kinds of IRAs: Traditional IRAs and Roth IRAs.

Techniques for Minimizing Penalties on Early Distributions

Usually, any distribution from an IRA before you reach age 59 1/2 is considered as an early distribution and is subject to a ten percent penalty on the taxable amount received in a distribution. There are 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 Using IRA Funds to Buy or Build Your First House - As much as $10,000 may be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, build or reconstruct a first home for yourself, your wife, you or your spouse's kid, you or your spouse's grandchild or you or your wife's parent or ancestor.

2. Using IRA Funds for Medical Bills - Penalty-free early distributions could be made if the funds are used to pay unreimbursed medical bills which exceed 7.5 percent 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 School Costs - Conventional IRAs can be also tapped to help 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 Contributions withdrawn are not matter of the ten percent penalty and there's no RMD with Roth IRAs. So as for Roth IRA earnings distributions to be tax-free, the account must have been opened for five years and the distributions must be made after reaching age 59 1/2. If you meet the five-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 required 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. 0% 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 always the same...zero.

3. Conversion Possibilities - Beginning after January 1, 2010 anyone, 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 don't have enough money set aside to do a 100% conversion you can do partial conversions.

4. University Expenses - 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 academy expenses.