Structuring IRA Distributions To Avoid Penalties - Safe Harbor Planning: Several Useful Techniques
IRA distribution rules are a mine field. One incorrect move and you could discover yourself faced with high taxes and penalties which could wipe out years of savings and investment. Complicating issues is the Darwinian evolution of IRAs which have taken place since the pioneer IRA was launched 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 do not follow the regulations, to the letter of the law. IRAs come in a lot of flavors but, for purposes of this article we'll focus on the two major kinds of IRAs: Traditional IRAs and Roth IRAs.
Strategies 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 ten percent penalty on the taxable amount received in a distribution. There are particular IRA distribution rules that can be used to avoid the burden of this early withdrawal penalty.
1. Using IRA Money to Purchase or Build Your First House - Up to $10,000 may be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, build or repair a first home for yourself, your wife, you or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 Medical Bills - Penalty-free early distributions can be made if the funds are used to pay unreimbursed medical bills which exceed 7.5 % of your adjusted total earnings. There's no condition to itemize deductions to be eligible for this exception.
3. Using IRA Money for School Costs - Traditional IRAs can also be tapped to aid fund school 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 policy 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 Contributions withdrawn are not matter of the ten percent penalty and there's no RMD with Roth IRAs.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 5 years and the distributions should be made after reaching age 59 1/2. If you fullfil the five-year rule but not the 59 1/2 year rule, distributions in excess of your contributions might be taxable and matter of 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, throughout the lifetime of the owner, allowing a larger legacy for their beneficiaries.
2. 0% Effective Tax Rate - Qualified distributions from Roth IRAs are not matter of income tax...ever. This means you are unaffected by future tax increases as your effective tax rate is always the same...zero.
3. Conversion Opportunities - Beginning after January 1, 2010 anyone, irrespective of their earnings level, may convert conventional IRAs into Roth IRAs. The tax on the taxable income for 2010 conversions can be deferred into 2011 and 2012. If you don't have sufficient money set aside to do a 100% conversion you can do partial conversions.
4. College Expenses - 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 academy expenses.