Structuring IRA Distributions To Avoid Penalties - Protected Harbor Planning: Some Helpful Techniques
IRA distribution rules are a mine field. One wrong move and you can find yourself faced with high taxes and penalties that may wipe out years of savings and investment. Complicating matters is the Darwinian evolution of IRAs which 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 severely punish those who don't follow the rules, to the letter of the regulation. IRAs come in several flavors but, for purposes of this article we will focus on the two chief 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 quantity received in a distribution. There're certain IRA distribution rules that might be used to avoid the burden of this early withdrawal penalty.
1. Using IRA Funds to Purchase or Construct Your First Home - Up to $10,000 may be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to purchase, build or reconstruct a first house for yourself, your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 Money for Medicinal Bills - Penalty-free early distributions can be made if the money are used to pay unreimbursed medical bills which exceed 7.5 percent of your adjusted total income. There is no condition to itemize deductions to be eligible for this exception.
3. Using IRA Funds for Academy Expenses - Conventional IRAs can be also tapped to help fund university costs; 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 regulations with respect to distributions. Contributions withdrawn are not matter of the 10% penalty and there is no RMD with Roth IRAs.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 must 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 matter of a 10% penalty.
1. No RMD - With Roth IRAs, there's 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, throughout the lifetime of the owner, allowing a larger legacy for their beneficiaries.
2. Zero Percent 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 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 - Because 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 school expenses.
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