Structuring IRA Distributions To Prevent Penalties - Protected Harbor Planning: Several Effective Ways
IRA distribution rules are a mine field. One wrong move and you could discover yourself faced with high taxes and penalties that may wipe out years of savings and investment. Complicating issues is the Darwinian evolution of IRAs that have taken place since the first IRA was introduced in '74 with the enactment of the Employee Retirement Income Security Act (ERISA ). Since '74, IRA policy have altered dramatically and laws was enacted to severely punish those who do not follow the rules, to the letter of the law. IRAs come in various flavors but, for purposes of this article we will focus on the two chief forms of IRAs: Traditional IRAs and Roth IRAs.
Strategies for Minimizing Penalties on Early Distributions
Usually, any distribution from an IRA before you reach age 59 1/2 is considered an early distribution and is subject to a ten percent penalty on the taxable amount 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 Using IRA Funds to Buy or Construct Your First House - Up to $10,000 might be withdrawn from an IRA as an early distribution penalty-free, as long as the distribution is used to purchase, construct or repair a first home for yourself, your wife,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 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 bills which exceed 7.5 percent of your adjusted gross earnings. There's no requirement to itemize deductions to be eligible for this exception.
3. Using IRA Funds for University Costs - Conventional IRAs can also be tapped to help fund college costs; however, the taxable amount of the distributions from these IRAs will be matter of income tax in the year of the distribution.
Roth IRA distribution rules
Roth IRAs have unique policy with respect to distributions. Contributions withdrawn are not matter of the ten percent penalty and there's no RMD with Roth IRAs.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 five-year rule but not the 59 1/2 year regulation, 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 operator is never needed to make a distribution out of their Roth IRA. As a result, Roth IRAs can grow, untaxed, throughout the lifetime of the owner, permitting 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 anyone, 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, such contributions can be a tax-free future funding source for your child's university expenses.