The ABCs of IRA distributions.
How to avoid unnecessary taxes and penalties.
Not sure how you go about getting money out of an IRA in a way that benefits you the most? You're not alone. If you ask 10 experts about the rules, penalties, and tax consequences of IRA distributions, you might get a variety of answers. And while we don’t have all the answers, we think everyone will agree with these key concepts.
Distribution rules for individually-owned IRAs differ from those of employer-sponsored plans. The rules also differ for the two types of IRAs—traditional and Roth. Distribution rules are also governed by your age when you begin to take money out as well as the length of time you plan to do so. Understanding these rules can mean the difference between tax savings and a potential tax liability as high as 50%. To avoid costly mistakes, consider the following guidelines when planning your retirement.
Getting your money out of a traditional IRA.
With a traditional IRA, your contributions may be tax deductible, depending upon your income and participation in an employer-sponsored qualified plan. However, distributions, at the time they are taken, may be taxable as income.
Your age is the determining factor.
If you withdraw IRA funds before age 59½, unless an exception applies, you can be hit with a 10% IRS penalty tax on any taxable amounts in addition to income taxes at the ordinary rates. The full amount of your distributions is taxable if you could deduct all contributions at the time they were made; if only a portion of your contributions were deductible, that portion—plus all earnings—are taxable.
Fortunately, there are a number of exceptions in which penalty tax free withdrawals can be made from your traditional IRA prior to age 59½, though income taxes still apply.
- By your beneficiaries, at your death.
- If you become disabled.
- To the extent your distributions do not exceed the amount of your deductible medical expenses. .
- If you are unemployed, to pay the costs of health insurance.
- If the money is used to pay qualifying medical expenses (when they exceed 7.5% of your adjusted gross income).
- If the money is used to pay for qualified higher education expenses for yourself, your spouse, children, or grandchildren.
- If you use the money (up to $10,000 lifetime limit) for the first-time purchase of a home for yourself, your spouse, children, or grandchildren.
Remember you must begin taking Required Minimum Distributions by April 1 of the year after the year you turn 70½ in order to avoid a 50% penalty tax.
Getting your money out of a Roth IRA.
A Roth IRA is significantly different than a traditional IRA.
- Contributions are not deductible. They are made with after-tax dollars.
- Contributions (though not earnings) can be withdrawn at any time without income tax consequences.
- Contributions can be made after age 70½. With traditional IRAs, contributions are not allowed beginning in the year in which you reach age 70½.
- Qualified distributions are completely income tax-free. Non-qualified withdrawals of earnings are subject to the 10% early withdrawal penalty tax, plus income tax.
In order for earnings from a Roth IRA to be distributed tax free, you must have held a Roth IRA for at least five taxable years AND one of the following criteria must be met:
- You are age 59½ or older.
- You are disabled.
- It is made to your beneficiaries after death.
- You use the money to purchase a first home; up to $10,000 lifetime.
Consult your tax advisor for more information regarding your specific situation.
Contact New York Life and its financial professionals for your rollover and retirement related questions.
This material is for informational purposes only. Neither New York Life nor its Agents provide tax, legal, or accounting advice. Please consult your own tax, legal, or accounting professional before making any decisions.