Structuring IRA Distributions To Prevent Penalties - Safe Harbor Planning: Some Effective Techniques


IRA distribution rules are a mine field. One incorrect move and you could 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 first IRA was launched in '74 with the enactment of the Worker Retirement Income Security Act (ERISA ). Since 1974, IRA rules have altered dramatically and laws was enacted to rigorously punish those who don't follow the rules, to the letter of the regulation. IRAs come in various flavors but, for reasons of this article we will focus on the 2 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 ten percent penalty on the taxable quantity received in a distribution. There are particular IRA distribution rules that can be used to avoid the burden of this early withdrawal penalty.

1. Using IRA Funds to Purchase or Build Your First House - Up to $10,000 may be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, build or rebuild a first home for yourself, your partner, you or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 Medical Expenses - Penalty-free early distributions can be made if the money are used to pay unreimbursed medicinal bills which exceed 7.5 % of your adjusted total earnings. There's no obligation to itemize deductions to qualify for this exception.

3. Using IRA Money for University Expenses - Conventional IRAs can also be tapped to help fund university costs; however, the taxable amount of the distributions from these IRAs shall 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 Contributions withdrawn are not subject to the ten percent penalty and there is no RMD with Roth IRAs.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 must 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 might be taxable and matter of a ten percent penalty.

1. No RMD - With Roth IRAs, there's no RMD at age 70 1/2. This means a Roth IRA owner is never required 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 anyone, irrespective of their income level, may convert traditional 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. School Costs - Because Roth IRA contributions may 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.










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