Structuring IRA Distributions To Avoid 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 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 Worker Retirement Income Security Act (ERISA ). Since 1974, IRA policy have changed dramatically and legislation was enacted to severely punish those who do not follow the policy, to the letter of the rule. IRAs come in various flavors but, for reasons of this article we'll focus on the 2 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 subject to a 10 percent penalty on the taxable quantity received in a distribution. There're specific IRA distribution rules that could be used to avoid the imposition of this early withdrawal penalty.

1. Using IRA Funds to Buy or Construct Your First Home - As much as $10,000 may be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, build or repair a first home for yourself, your wife, you or your spouse's child, you or your spouse's grandchild or you or your spouse's parent or ancestor.

2. Using IRA Money for Medicinal Expenses - Penalty-free early distributions could be made if the funds are used to pay unreimbursed medical expenses which exceed 7.5 percent of your adjusted gross income. There is no obligation to itemize deductions in order to be eligible for this exception.

3. Using IRA Funds for Academy Expenses - Conventional IRAs can also be tapped to aid 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 rules with respect to distributions. Contributions withdrawn are not subject to the 10% penalty and there's no RMD with Roth IRAs. In order for Roth IRA earnings distributions to be tax-free, the account must have been opened for 5 years and the distributions must be made after reaching age 59 1/2. If you meet the 5-year rule but not the 59 1/2 year rule, 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 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, allowing 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 constantly the same...zero.

3. Conversion Possibilities - 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 deferred into 2011 and 2012. If you do not have enough money set aside to do a 100% conversion you can do partial conversions.

4. College Expenses - Because 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 university expenses.