Withdrawals

Using Your IRA For A Financial Emergency

March 2, 2016 by IRA Services

Traditional-IRA In cases of severe financial emergency, it might make sense to pull cash from your traditional IRA – even if you’ll be subject to the 10-percent early-withdrawal penalty. Such crises are those that have serious negative impact to your life, family, and major assets.

What Constitutes a Financial Emergency?

Before resorting to your retirement fund, determine whether you can access other resources first. But if an IRA withdrawal is your only option, make sure it is to pay for one of the following:

Legal fees and court costs to minimize the risk of job loss and incarceration.
Necessary medical treatment for you, your spouse, or your child who is not covered by insurance.
Legal fees associated with maintaining custody of a child, including the cost of adoption.
Debt that must be paid quickly to avoid the partial or total loss of your vehicle, business, home, or other major investment. In some instances, Congress passes legislation to allow victims of serious natural disasters to receive distributions without paying a penalty.

Certain Expenses Could Save You 10 Percent

Depending on your situation, you might be able to avoid paying a penalty when making an early withdrawal from your IRA. Such circumstances include your inheritance and the cost of medical care, health insurance, and higher education.

Medical Care

Qualifying medical costs are expenses not reimbursed by your insurer. These must exceed 10 percent of your adjusted gross income. You must make the withdrawal in the same year you incur the cost.

Health Insurance

In order to be eligible for a penalty-free withdrawal, the cost of health insurance must pay for coverage for you, your spouse, or your dependents following a job loss. You must receive unemployment compensation for 12 consecutive weeks after becoming unemployed. You also need to receive the distribution in the same or subsequent year in which you received the unemployment benefits – and no later than 60 days after becoming re-employed.

Higher Education

Eligible higher education expenses include the cost of you, your spouse, and the children or grandchildren of you or your spouse to enroll at a college, university, or vocational school that participates in a federal student aid program. Expenses include tuition, school fees, books, and associated items such as lab supplies. Room and board are covered as long as the student attends at least half time.

Inheritance

An inheritance distributed to a beneficiary (or to your estate) are not subject to the 10-percent penalty if you pass before age 59½.

Home

Home-related expenses include a $10,000 distribution for an individual or $20,000 distribution for a couple to buy, build, or rebuild a first home. The home must be for you (and/or your spouse) or your children, grandchildren, or parents. First-time homebuyers are people who did not own a house in the two years preceding the sale of a new home or lot.

Disability

Eligible disability costs are those related to a lasting and continuous medical condition that prevents an individual from engaging in gainful employment. Proof from your doctor is required.

More Penalty-Free Situations

Other special circumstances could exclude you from paying the early-withdrawal fee. There may be additional forms and procedures associated with these scenarios:

If you are getting a divorce, you can split the IRA between you and your former spouse without penalty.
If you are converting a traditional IRA into a Roth IRA, you will not have to pay the penalty.
If you are a member of the military called to duty after Sept. 11, 2001 who served for at least six months, you will not have to pay a penalty if you withdraw during active duty.

Ask an Accountant

An attorney or accountant can help you effectively access funds in a traditional IRA. They can also help you determine the necessary paperwork and can advise you on how taking a withdrawal will affect your taxes.

How To Avoid Taxes From Required Minimum Distributions

October 23, 2015 by IRA Services

IRA, Withdrawal, Taxes One of the hallmark benefits of investing in a retirement plan is the ability to defer taxes on your savings and investment gains. But the IRS won’t let you get away with this perk indefinitely, and you will eventually have to start paying taxes on your savings through IRS-mandated withdrawals known as Required Minimum Distributions (RMDs).

For those that don’t necessarily need to make withdrawals on their retirement fund on a regular basis, or those that would like to postpone taxes further, RMDs can be frustrating and lead to extra taxes. First, RMDs add to taxable income, driving up your tax liability. Also, withdrawing from your retirement account means your savings are no longer in a tax-deferred account and if you reinvest the money through a regular brokerage account after the RMD, you’ll be paying extra taxes on your future investment gains as well.

If it is more beneficial for you to continue deferring taxation on your savings, as there are a few strategies you can use to avoid RMDs.

How do RMDs Work?

First, let’s back up to explain the basics of RMDs. RMDs only apply to retirement plans, like Traditional IRAs and Traditional 401(k)s, that trigger a tax on withdrawals. There are no RMDS for accounts with tax-free withdrawals, such as Roth IRAs.

The rules around RMDs vary by type of account. Traditional IRAs, for example, require RMDs each year once you turn 70 ½ years old. If you have a work retirement plan, you don’t need to make RMDs until you either turn 70 ½ or retire, whichever is later.

RMD amounts also vary, and are calculated based on your life expectancy and your account balance. To find your RMD, divide your account balance by your expected life expectancy (using a chart prepared by the IRS).

Penalties for not paying your RMD every year are among the most onerous in the tax code, at 50% of the RMD amount. For example, if your RMD is $10,000 and you don’t make a withdrawal, you’ll owe $5,000 in extra taxes that year.

So, how do you avoid RMDs if you don’t actually require those annual withdrawals to meet your needs? Roth IRAs are your best bet, and there are a few different rollover strategies to consider.

1. Make a lump-sum Roth IRA rollover

Rolling over your entire Traditional IRA or 401(k) balance into a Roth IRA has pros and cons. The year that you make the rollover, you will need to pay taxes on the entire account balance, meaning you will take a fairly sizable, one-time tax hit.

But, on the upside, you will never have to make RMDs in the future, and your savings will grow tax-free from that point on. This approach can make sense if you are in a relatively low tax bracket and have the money to pay off all your retirement plan taxes right away.

2. Spread out small transfers to a Roth IRA

Once you turn 59 ½, you can also choose to make smaller withdrawals every year from your taxable retirement plans (Traditional IRAs and 401(k)s) to a Roth IRA. By making smaller withdrawals, you can avoid getting pushed into a higher tax bracket by that extra income, and taxes on withdrawals will be fairly minimal.

The downside of this approach is that it requires more effort on your end, and you will see less tax-free growth in the future since your Roth IRA balance will accumulate more slowly than a lump sum transfer.

This strategy works best if you finish your Roth rollover before you start taking Social Security because taxable retirement plan withdrawals add to your total income, which can lead to extra taxes on your Social Security payments. Keep in mind that it usually does not make sense to delay Social Security after age 70.

Both approaches have their merits and can help you minimize if not completely avoid RMDs. By planning ahead, you can take money out of retirement plans on your schedule to make sure you have the most tax-effective approach. In the meantime, read more about making this year’s Required Minimum Distribution in our next article.

How To Minimize Taxes On Your IRA Withdrawals

September 29, 2015 by IRA Services

Protecting his assets One of the main advantages of investing through an IRA is that, as long as your money stays in the account, taxes on investment gains are delayed. But when it comes time to start making withdrawals, taxes can start accruing fast.

Depending on what type of account you have and when you make the withdrawals, your tax bill can vary significantly. Here are some things to keep in mind so you can minimize taxes on your IRA withdrawals.

Account Type Matters: Traditional vs. Roth IRA

There are two main types of IRAs – Traditional and Roth – both have very different tax rules, and Roth accounts are best for minimizing taxes upon withdrawal. The Traditional IRA gives you a tax deduction on the front end of your IRA, when you make a contribution. But the Roth IRA, instead of giving you an immediate tax benefit for contributions, will yield tax savings at the time of withdrawal.

Timing Matters Too: Early Withdrawals and Exemptions

Since IRAs are intended to be a retirement account, taking money out before you stop working or hit a certain age will usually lead to taxes. But again it depends on what type of account you have.
With a self-directed IRA, money taken out before you turn 59 ½ is considered an early withdrawal by the IRS, and thus subject to taxes.

However, if you have a Roth IRA you are allowed to take out contributions – but not investment gains – without owing any taxes. For example, if you added $10,000 to your Roth, you can take out $10,000 tax-free. If you withdraw any money that you have earned on investments from that same Roth IRA, you will owe income taxes on amount withdrawn. Depending on how old you are when you take the money out, you might also owe an additional 10 percent early withdrawal penalty.

Similarly, withdrawals made at any time on a Traditional IRA are subject to income tax (and the early withdrawal penalty if you are younger than 59 ½).

But there are ways to avoid the early withdrawal penalty and taxes, depending on your circumstances. If you qualify for any of the categories below, you may be able to minimize taxes on your IRA withdrawals.

1. Disability – If you become disabled and can’t work, you can take money out of your IRA without penalty.
2. First home purchase – You can take out up to $10,000 from you IRA penalty-free to buy or build your first home.
3. Medical expenses – If you have medical bills that add up to more than 10 percent of your adjusted gross income for the year, you can take money out of your IRA to pay bills that are over this limit.
4. Health insurance – If you are unemployed, you can make withdrawals to buy health insurance.
5. Tax lien – If you are behind on your income taxes, the IRS could place a lien against your IRA for payment. You could then take money out penalty-free to pay your back taxes.
6. Higher education – If you or a family member goes to a qualified college or university, you can take money out of your IRA to pay for school expenses like tuition, books, and room and board.
7. Called up to active duty for the military reserves– If you are a member of the military reserves and called up for a period of active duty that lasts at least 180 days, you can make withdrawals while on active duty.
8. Equal periodic payments – You can divide up your IRA into equal periodic payments based on your life expectancy, as calculated by the IRS. You’d need to receive these periodic payments for at least 5 years or until you turn 59 ½, whichever comes first, to avoid the penalty.
9. Death – If you die before retiring, the person who inherits your IRA can make withdrawals without owing the penalty.

Minimizing Taxes After Retirement

Once you turn 59 ½, you can start making retirement withdrawals from your IRA without fear of the 10 percent penalty, regardless of whether you are still working or not. Withdrawals on Roth IRAs are completely tax-free. But any withdrawals on a Traditional IRA will be taxed as income, not the lower capital gains rate.

In order to avoid getting pushed into a higher tax bracket due to income gains from Traditional IRA withdrawals, you may want to balance out those withdrawals with other IRA accounts during retirement. For example, if you split your savings between a Roth and Traditional IRA, you may want to take money out of both accounts every year to avoid a hefty tax hit.

Another common strategy involves spending the money in your Roth IRA and regular brokerage account while keeping your savings in the Traditional IRA, since that money will continue to grow while deferring taxes. But there is a catch. When you turn 70 ½, you must start making the Required Minimum Distributions – IRS-mandated withdrawals calculated by your account balance and life expectancy – from your Traditional IRA. If you don’t make these required withdrawals annually, the IRS will charge you a penalty of 50 percent of your calculated RMD.

Some people view their IRA account as an inheritance for heirs. If that’s the case, keep in mind that an inherited IRA retains its tax status. Both a Traditional and Roth IRA can be inherited, and their withdrawals will be subject to the same tax rules as the original account owner.

You worked hard to build your retirement savings so make sure that money doesn’t just go to the IRS. Keep reading to learn more about IRA strategies and Required Minimum Distributions.