Almost all of us put money into some type of retirement plan with the goal of one day being able to retire and live comfortably.
Sometimes, though, you find yourself in need of a little extra money for things such as attending college, buying a home, assisting with medical expenses, and the list goes on. So, you decide to take an early IRA distribution to help pay for these expenses. While these are all very important and necessary expenses, understand that once a distribution has been made from an IRA, a taxable event has occurred.
Taxable Event - What it will cost you
In addition to paying income tax on the distribution, there may be an additional 10% penalty on an early distribution that could apply to taxable distributions made before one reaches age 59 ½. Fortunately, there may be some good news; there are a number of circumstances that can result in an exception to the 10% penalty.
Let's take a look at the exceptions to the 10% IRA withdrawal penalty for a distribution prior to age 59 ½ and the circumstances that must occur :
While some of these seem to be and are relatively straightforward, there are additional rules that can disqualify you from claiming an exception to an early IRA distribution.
Therefore, it is important to seek the advice of a professional BEFORE taking any early distribution, particularly if you intend to claim one of the exceptions.
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For example, with regard to the exception for a first time home purchase, (1) there is a $10,000 lifetime limit, (2) you (and your spouse if applicable) must not have owned a principal residence within the past two years, and (3) the funds distributed must be spent within 120 days on qualified acquisition costs. As you can see, it is important to drill down beyond the surface of the distribution rules.
These exceptions apply to traditional IRAs, Roth IRAs, Self Employed Pension (SEP) IRAs, and Simple IRAs. It is important to note that special rules apply to the taxation of distributions from a Roth IRA. Since money contributed to a Roth IRA is always after-tax dollars, in the event of an early distribution, only the earnings in the Roth IRA are potentially subject to a penalty.
Roth IRAs - A word for the wise
It is important to understand the hierarchy of Roth distributions. A distribution from a Roth IRA is treated as first coming from annual contributions, which will come out both tax and penalty-free, even if the owner is under 59½. Then, the distributions are treated as coming out from Roth Conversions (generally funds converted from a traditional IRA). This amount is first allocated to the taxable portion of the converted funds and then to the nontaxable portion of the converted funds.
When considering whether to take an early IRA distribution, it is important to talk to one of the tax professionals at Zinner & Co. to understand the options available to you. Each person's tax situation is different and my colleagues and I are well versed to help you not only understand, but also plan the most effective and meaningful strategy to strengthen your financial foundation.
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Learn more. Contact us at info@zinnerco.com or call 216-831-0733. We're ready to have the conversation.