Structuring IRA Distributions To Prevent Penalties - Secure Harbor Planning: Several Helpful Ways
IRA distribution rules are a mine field. One incorrect move and you can find yourself faced with high taxes and penalties that could wipe out years of savings and investment. Complicating issues is the Darwinian evolution of IRAs which have taken place since the first IRA was launched in 1974 with the enactment of the Employee Retirement Income Security Act (ERISA ). Since 1974, IRA rules have altered dramatically and legislation was enacted to rigorously punish those who do not follow the regulations, to the letter of the rule. IRAs come in several flavors but, for reasons of this article we will focus on the two major types of IRAs: Traditional IRAs and Roth IRAs.
Approaches for Minimizing Penalties on Early Distributions
Normally, 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 quantity received in a distribution. There are specific IRA distribution rules that could be used to avoid the burden of this early withdrawal penalty.
1. Using IRA Money to Purchase or Build Your First Home - Up to $10,000 may be withdrawn from an IRA as an early distribution penalty-free, as long as the distribution is used to buy, construct or rebuild a first home for yourself, your spouse, you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 money are used to pay unreimbursed medicinal costs which exceed 7.5 % of your adjusted gross earnings. There's no condition to itemize deductions in order to qualify for this exception.
3. Using IRA Funds for University Expenses - Conventional IRAs can be also tapped to help fund university expenses; however, the taxable amount of the distributions from these IRAs shall be matter of income tax in the year of the distribution.
Roth IRA distribution rules
Roth IRAs have unique regulations with respect to distributions. Contributions withdrawn aren't matter of the ten percent penalty and there's no RMD with Roth IRAs.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 5-year rule but not the 59 1/2 year rule, distributions in excess of your contributions will 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 owner 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. 0% Effective Tax Rate - Qualified distributions from Roth IRAs aren't 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 Possibilities - Beginning after January 1, 2010 anybody, irrespective of their income 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. School Costs - As Roth IRA contributions may 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.
