Individual Retirement Accounts (IRAs) can be an excellent way to save for the future, but once you reach a certain age, the IRS requires that a certain minimum amount be withdrawn annually from them.
How much you owe depends on various factors, including whether or not the withdrawal comes from a traditional IRA and your age. There may also be penalties applicable.
First-time homebuyer exception
Typically, contributions and distributions made to an IRA incur income tax; however, first-time homebuyers have an exception to this rule.
IRS regulations allow qualifying first-time homebuyers to withdraw up to $10,000 from an IRA without incurring the 10% early withdrawal penalty. In order to be eligible, they must purchase or build their primary residence within 120 days after receiving distribution and use these funds towards its purchase, construction, or rebuilding.
This rule only applies to traditional IRAs, not Roth IRAs, self-employment plans, 403(b) annuities or SIMPLE IRAs. Any taxable amounts received must be reported on your federal tax return and reported by your IRA custodian to the IRS as well. For assistance or any further questions on this matter please consult with a tax professional who will help determine if you should withdraw money from your IRA and what other ways may exist to provide down payments on a home purchase.
Medical expenses
When withdrawing funds from traditional, SEP or SIMPLE IRAs before reaching age 59.5 without meeting an exception criteria, typically ordinary income tax will apply. But in cases of serious medical expenses you may be eligible to tap your IRA without penalty.
In order to qualify, unreimbursed medical expenses must exceed 7.5% of your AGI for the year you withdraw funds from an IRA. This includes costs associated with diagnosing, preventing or treating disease as well as premium payments made via your IRA for unemployed family members of over 12 weeks duration.
Other exceptions allow penalty-free withdrawals to cover qualifying higher education expenses for yourself, your spouse and any children; alimony payments; and first-time homebuyer costs. You may also make distributions known as substantially equal periodic payments that span your life expectancy without incurring the 10% penalty fee. Furthermore, permanently disabled people, those fulfilling an IRS levy or having to make the withdrawal because of a deceased spouse can also escape this tax penalty.
Roth IRA
Roth IRA contributions are made using after-tax dollars, so when withdrawn they won’t incur taxes when you withdraw them. However, any investment growth that these funds generate remains taxable.
The IRS allows you to withdraw contributions at any time without penalty; however, any earnings withdrawal will incur income taxes, unless an exception applies.
One exception would be using your money to purchase your first home, cover medical expenses or cover health insurance premiums for yourself, your spouse or any dependents without incurring penalties or taxes.
Taxes will only apply on earnings-related distributions if they do not fall into one of the exception categories, such as five years of account ownership, reaching age 59 1/2 or fulfilling any other requirements. As an alternative, you could roll over the distribution into another qualified retirement account via trustee-to-trustee transfer or direct transfer and save taxes and penalties by doing this instead.
Required minimum distributions
The required minimum distribution rules exist to prevent people from using retirement accounts as an avenue to evade paying taxes. They typically begin taking effect at age 73 and can be calculated by dividing your prior year-end account balance by an IRS life expectancy factor.
If you fail to withdraw the correct RMD each year, the IRS imposes a 25% penalty; this can be reduced to 10% if corrective action is taken quickly.
This rule affects traditional, SEP and SIMPLE IRAs as well as workplace retirement plans such as 401(k), 403(b)s and 457(b)s; it also covers inherited IRAs. These new rules effectively eliminate stretch IRA estate-planning strategies used by some heirs to extend tax deferral benefits – providing yet another reason to start planning early with help from a financial advisor.
