Recent changes to IRA withdrawal rules have created considerable confusion, so for further guidance you should seek guidance from either the IRS or financial advisor.
Distributions made from an IRA prior to age 59 1/2 can incur taxes and penalties, except under certain specific exceptions. Here are the main ones:.
Taxes
An Individual Retirement Account, or IRA, provides significant tax advantages when saving for retirement. Commonly used by self-employed individuals and small business owners alike, but also available to employees without access to workplace retirement plans.
Withdrawals from Traditional and SEP IRAs are subject to income taxes, as well as an additional 10% penalty if taken before turning 59 1/2. Exceptions exist, however, which allow penalty-free withdrawals for higher education costs, unreimbursed medical expenses exceeding 7.5% of your adjusted gross income and first time home purchases.
If you plan to transfer the balance of your IRA from one custodian to another, the safest approach would be a trustee-to-trustee transfer rather than taking physical distribution. This leaves a full paper trail and prevents inadvertent errors which could incur tax penalties. You must also begin taking required minimum distributions at age 70 1/2.
Withdrawals
Typically, any money withdrawn from an IRA before age 59 1/2 will incur income tax and an early withdrawal penalty of 10%. There are exceptions, however. You can avoid this penalty if the money is used to cover qualified medical or higher education expenses, unreimbursed unemployment compensation costs or first-time home purchase expenses. Moreover, Substantially Equal Periodic Payments from your IRA allow you to manage long-term expenses without incurring tax liability distributions.
Other exceptions may include hardship withdrawals to cover unexpected expenses such as home repairs or disaster-related costs; and withdrawals to pay unreimbursed medical costs exceeding 7.5% of adjusted gross income. There may be limitations associated with these rules; so discuss this matter with your financial advisor for the best approach for you and any possible implication to use these provisions.
Rollovers
By moving money from an employer-sponsored account like a 401(k), 403(b), or 457(b), into an IRA, you’re taking advantage of its tax advantages while consolidating savings. But be mindful of any rules involved with the transition process before doing it.
Direct rollover is often the best solution, as your former plan administrator can send funds directly to your new IRA provider without risk of errors occurring along the way.
An indirect rollover requires you to physically accept the distribution, usually in the form of a check. Once received, you have 60 days to deposit the funds (plus any tax withheld) into a new IRA – otherwise, the IRS treats this distribution as regular withdrawal and could levy an early withdrawal penalty on you.
If you’re considering rolling over your IRA, consider an online broker or robo-advisor as NerdWallet has reviewed several such providers that take account fees, minimums, investment choices, customer support capabilities and mobile app accessibility into consideration when rating them.
In-Kind Distributions
In-kind distributions may not be as popular but they can offer some tax benefits that cash withdrawals do not. By moving assets from an IRA into your taxable brokerage account in-kind instead of selling stocks first, this method helps avoid risk that selling beforehand could cause their value to drop too far and require you to rebuy them at higher costs in order to meet RMDs.
If you don’t need the income from selling shares of stock immediately for living expenses, an in-kind distribution may be an effective way to reach retirement goals without liquidating investments that you prefer keeping. Just keep in mind that when taking an in-kind RMD, your investments’ basis resets, which may increase your ordinary income tax bill when selling later on.
