Structuring IRA Distributions To Avoid Penalties - Safe Harbor Planning: Some Useful Techniques
IRA distribution rules are a mine field. One wrong move and you can discover yourself faced with high taxes and penalties that can 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 '74 with the enactment of the Worker Retirement Income Security Act (ERISA ). Since 1974, IRA rules have altered dramatically and legislation was enacted to rigorously punish those who don't follow the regulations, to the letter of the regulation. IRAs come in various flavors but, for reasons of this article we will focus on the two key types of IRAs: Traditional IRAs and Roth IRAs.
Methods for Minimizing Penalties on Early Distributions
Normally, any distribution from an IRA before you reach age 59 1/2 is considered as an early distribution and is matter of a 10 percent penalty on the taxable quantity received in a distribution. There are specific IRA distribution rules that might be used to avoid the imposition of this early withdrawal penalty.
1. Using IRA Funds to Purchase or Construct Your First House - As much as $10,000 might be withdrawn from an IRA as an early distribution penalty-free, as long as the distribution is used to buy, construct or rebuild a first house for yourself, your partner, 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 Medicinal Expenses - Penalty-free early distributions can be made if the money are used to pay unreimbursed medical costs which exceed 7.5 % of your adjusted total earnings. There's no condition to itemize deductions in order to qualify for this exception.
3. Using IRA Funds for College Expenses - Conventional IRAs can be also tapped to aid fund academy expenses; 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 regulations with respect to distributions. Contributions withdrawn are not matter of the 10% penalty and there's no RMD with Roth IRAs.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 5-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 operator is never needed to make a distribution out of their Roth IRA. As a result, Roth IRAs can grow, untaxed, during 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're 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 traditional IRAs into Roth IRAs. The tax on the taxable income for 2010 conversions can be delayed into 2011 and 2012. If you do not have sufficient money set aside to do a 100% conversion you can do partial conversions.
4. University Expenses - As Roth IRA contributions might 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 college expenses.
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