Withdrawals made prior to age 59 1/2 are subject to taxes and a 10% penalty–draining away some of your tax savings over time. But there may be exceptions:
Roll your IRA money over into another IRA–such as one at another firm–without incurring taxes or penalties, but be aware: this process can only be done once every 12-months.
RMDs
As soon as you reach a certain age, the IRS mandates minimum distributions (RMDs) from many types of retirement savings accounts. While typically taxed as income, you can avoid penalties by rolling your RMD into another IRA or tax-deferred account.
To calculate an RMD, it is important to know both your age and year-end balance in each taxable retirement account. The IRS offers calculation tables which help determine how much should be withdrawn based on life expectancy and type of account.
RMD rules can be complex, with penalties applied if they’re not taken by their due dates. Working with a financial advisor to create a withdrawal strategy tailored specifically to your unique circumstances is highly advised. RMD rules also apply to inherited IRAs although owners of those accounts have the option of rolling the funds over into another tax-deferred account if desired; as well as self-employed accounts such as SEP IRAs and SIMPLE IRAs which fall under this category.
In-Kind Distributions
Rules regarding withdrawals and penalties differ depending on the type of IRA account you possess. Traditional, Rollover, SEP and SIMPLE IRAs allow contributors to contribute money on a pre-tax basis up until age 59 1/2 or withdraw funds before starting withdrawals.
Once you reach age 59 1/2, RMDs are mandated from your IRA. While liquidating shares and withdrawing cash are options available to you, an in-kind distribution allows for asset transfers without cash payments being necessary.
In-kind distributions provide you with an alternative means of meeting your financial goals while still holding onto stock shares. Furthermore, this approach often comes with tax benefits not available through cash distributions, including net unrealized appreciation and the elimination of transaction fees. Unfortunately, in-kind distributions may come with drawbacks such as illiquidity or concentration risk which makes consultation with your financial planner important before considering an in-kind distribution option as this must fit within the scope of your retirement plan and overall goals.
60-Day Rollover
The 60-day rollover allows IRA funds to be withdrawn and reinvested into another retirement account without incurring taxes if done within its designated timeframe. Otherwise, any distribution outside this window would be treated as a taxable withdrawal and may incur income taxes and penalties depending on individual’s age and situation.
An easy way to abide by the 60-day rule and avoid unnecessary taxes and penalties is through direct rollover. This involves receiving your distribution check from your first IRA company and depositing it directly into a second one. This method ensures compliance with the rules while saving on fees.
Keep meticulous records when employing the 60-day rule. From the moment your distribution arrives at your new IRA, time starts ticking away – be sure to use a calendar or reminder and date stamp all correspondence.
Taxes
Savers who raid their retirement accounts can face severe penalties, and it is best to refrain from doing so as much as possible. But there may be exceptions.
The IRS allows tax-free distributions of education costs, such as tuition fees, books and supplies. Other expenses eligible for such distributions are certain housing costs such as room and board, as well as specialized educational services costs.
Clients can also use their IRAs to cover medical expenses that exceed 7.5% of adjusted gross income in any one year; and first-time home buyers can withdraw up to $10,000 penalty free from their IRA.
Beneficiaries may take steps to “stretch out” IRA withdrawals over multiple years in order to avoid paying penalties, but this strategy should only be undertaken when there is an emergency or it makes financial sense. Otherwise, beneficiaries risk missing their 60-day rollover window and incurring taxes and penalties as well as forgoing potential tax-deferred growth on funds.
