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

IRA distribution rules are a mine field. One wrong move and you could find yourself faced with high taxes and penalties that may wipe out years of savings and investment. Complicating matters is the Darwinian evolution of IRAs which have taken place since the pioneer IRA was introduced in '74 with the enactment of the Employee Retirement Income Security Act (ERISA ). Since 1974, IRA policy have changed dramatically and legislation was enacted to severely punish those who don't follow the regulations, to the letter of the law. IRAs come in various flavors but, for purposes of this article we will focus on the 2 major kinds of IRAs: Traditional IRAs and Roth IRAs.

Strategies for Minimizing Penalties on Early Distributions

Normally, any distribution from an IRA before you reach age 59 1/2 is considered as an early distribution and is subject to a 10 percent penalty on the taxable amount received in a distribution. There are particular IRA distribution rules that can be used to avoid the imposition of this early withdrawal penalty.

1. Using IRA Money to Purchase or Construct Your First Home - As much as $10,000 may be withdrawn from an IRA as an early distribution penalty-free, as long as the distribution is used to purchase, build or repair a first home for yourself, your partner, you or your spouse's kid, you or your spouse's grandchild or you or your spouse's parent or ancestor.

2. Using IRA Funds for Medical Expenses - Penalty-free early distributions could be made if the funds are used to pay unreimbursed medical expenses which exceed 7.5 % of your adjusted total income. There's no requirement to itemize deductions in order to be eligible for this exception.

3. Using IRA Money for School Costs - Conventional IRAs can be also tapped to help fund academy costs; however, the taxable amount of the distributions from these IRAs will be matter of income tax in the year of the distribution.

Roth IRA distribution rules

Roth IRAs have unique rules with respect to distributions. Contributions withdrawn are not subject to the 10% penalty and there's no RMD with Roth IRAs. In order for Roth IRA earnings distributions to be tax-free, the account should have been opened for five years and the distributions must be made after reaching age 59 1/2. If you fullfil the five-year rule but not the 59 1/2 year rule, distributions in excess of your contributions will be taxable and matter of a 10% penalty.

1. No RMD - With Roth IRAs, there is no RMD at age 70 1/2. This means a Roth IRA operator is never required to make a distribution out of their Roth IRA. As a result, Roth IRAs can grow, untaxed, throughout the lifetime of the owner, permitting a larger legacy for their beneficiaries.

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

3. Conversion Possibilities - Beginning after January 1, 2010 anyone, irrespective of their income level, may convert conventional IRAs into Roth IRAs. The tax on the taxable income for 2010 conversions can be deferred into 2011 and 2012. If you do not have enough money set aside to do a 100% conversion you can do partial conversions.

4. University Expenses - Because Roth IRA contributions might be withdrawn, tax-free, penalty-free, at any time, such contributions can be a tax-free future funding source for your child's college expenses.

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