Structuring IRA Distributions To Avoid Penalties - Safe Harbor Planning: Several Useful Techniques
IRA distribution rules are a mine field. One incorrect move and you can discover yourself faced with high taxes and penalties that could wipe out years of savings and investment. Complicating matters is the Darwinian evolution of IRAs that have taken place since the pioneer IRA was introduced in '74 with the enactment of the Worker Retirement Income Security Act (ERISA ). Since '74, IRA rules have altered dramatically and laws was enacted to severely punish those who do not follow the regulations, to the letter of the law. IRAs come in lots of flavors but, for reasons of this article we'll focus on the two chief forms 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 as 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 burden of this early withdrawal penalty.
1. Using IRA Money to Buy or Construct Your First Home - As much as $10,000 might be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, construct or reconstruct a first home for yourself, your spouse, you or your spouse's kid, you or your spouse's grandchild or you or your spouse's parent or ancestor.
2. Using IRA Funds for Medicinal Bills - Penalty-free early distributions can be made if the money are used to pay unreimbursed medicinal expenses which exceed 7.5 percent of your adjusted total income. There's no condition to itemize deductions to qualify for this exception.
3. Using IRA Funds for Academy Costs - Traditional IRAs can be also tapped to help fund university 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 Contributions withdrawn aren't subject to the ten percent penalty and there's no RMD with Roth IRAs. In order for Roth IRA earnings distributions to be tax-free, the account should have been opened for 5 years and the distributions should be made after reaching age 59 1/2. If you meet the 5-year rule but not the 59 1/2 year regulation, 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 operator 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 are not subject to income tax...ever. This means you're unaffected by future tax increases as your effective tax rate is always the same...zero.
3. Conversion Chances - Beginning after January 1, 2010 anybody, irrespective of their earnings 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. College Expenses - Because 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 university expenses.
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