Structuring IRA Distributions To Prevent Penalties - Secure Harbor Planning: Some Helpful Methods

IRA distribution rules are a mine field. One wrong move and you can find yourself faced with high taxes and penalties which could wipe out years of savings and investment. Complicating matters is the Darwinian evolution of IRAs which have taken place since the first IRA was launched in 1974 with the enactment of the Worker Retirement Income Security Act (ERISA ). Since 1974, IRA rules have changed dramatically and laws was enacted to severely punish those who don't follow the policy, to the letter of the rule. IRAs come in a lot of flavors but, for reasons of this article we will focus on the two major kinds of IRAs: Traditional IRAs and Roth IRAs.

Techniques for Minimizing Penalties on Early Distributions

Normally, any distribution from an IRA before you reach age 59 1/2 is considered an early distribution and is matter of a ten percent penalty on the taxable quantity received in a distribution. There are specific IRA distribution rules that can be used to avoid the burden of this early withdrawal penalty.

1. Using IRA Money to Purchase or Build Your First House - Up to $10,000 might be withdrawn from an IRA as an early distribution penalty-free, as long as the distribution is used to buy, build or repair a first home for yourself, your partner, you or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 Medicinal Expenses - Penalty-free early distributions can be made if the funds are used to pay unreimbursed medicinal expenses which exceed 7.5 % of your adjusted gross earnings. There is no obligation to itemize deductions in order to qualify for this exception.

3. Using IRA Money for University Costs - Conventional IRAs can also be tapped to aid fund school 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 rules with respect to distributions. Contributions withdrawn aren't subject to the 10% penalty and there is no RMD with Roth IRAs. So as for Roth IRA earnings distributions to be tax-free, the account must 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 will 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 needed to make a distribution out of their Roth IRA. As a result, Roth IRAs can grow, untaxed, during the lifetime of the owner, permitting a larger legacy for their beneficiaries.

2. 0% Effective Tax Rate - Qualified distributions from Roth IRAs are not matter of income tax...ever. This means you are unaffected by future tax increases as your effective tax rate is constantly the same...zero.

3. Conversion Opportunities - 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 deferred into 2011 and 2012. If you don't have enough money set aside to do a 100% conversion you can do partial conversions.

4. University Costs - As Roth IRA contributions may 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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