Playing by the IRA Rules

Even the rebellious at heart may choose to play by the rules governing Individual Retirement Accounts (IRAs) to avoid tax penalties. IRAs offer favorable tax-deferral benefits to individuals who are saving for retirement, but with those benefits come certain rules about when distributions may be taken.

Contributions to a traditional IRA, depending on your income and participation in employer sponsored plans, may entitle you to certain current income tax deductions. Furthermore, because your funds are not taxed until distributions begin, your savings have the potential for tax-deferred growth. Generally, IRAs are designed to work as long-term savings vehicles, but you may be able to withdraw funds early and with- out penalty, provided your situation qualifies as an exception.

The Age 59 1⁄2 Rule

The age 591⁄2 rule stipulates that, if you take distributions from your traditional IRA before you reach the age of 591⁄2, you may be subject to a 10% Federal income tax penalty in addition to regular income tax. However, you may not have to pay the 10% Federal income tax if your early distribution meets certain requirements.

Exceptions

You may be eligible for penalty-free qualified distributions, if one of the following exceptions applies:

You are taking qualified distributions as the beneficiary of a deceased IRA owner. If you inherit an IRA, there are stipulations outlining when you must begin taking distributions based on your relationship to the decedent. For nonspousal beneficiaries, when the IRA owner died, not the age of the beneficiary, determines when distributions must be taken; therefore, there is no penalty if the beneficiary has not yet reached age 59 1⁄2. The age of the beneficiary will determine only the amount of the required minimum distribution (RMD). The same is true for spousal beneficiaries who do not opt to treat an inherited IRA as their own. The exception does not apply to spousal beneficiaries who opt to treat the account as their own IRA.

You are paying for certain first-time homebuyer expenses, generally referred to as qualified acquisition costs, such as buying, building, or renovating a first home. Distributions, which may not exceed $10,000, may be used to cover qualified costs for you, your spouse, your children, or your grandchildren.

You, your spouse, or depen
dents have unreimbursed
medical expenses that total
more than 7.5% of your ad
justed gross income (AGI). 
If a medical expense for you,
your spouse, or a dependent
 qualifies as an itemized deduction on your income tax re- turn, it will generally qualify as an exception.

The distributions are part of a series of substantially equal payments that meet certain annuity criteria. The Internal Revenue Service (IRS) currently endorses three methods for determining an early distribution schedule: the life expectancy method, the amortization method, and the annuitization method. Once an early distribution schedule is established, it must be maintained for five years or until you reach age 59 1⁄2, whichever is later. Furthermore, at least one distribution must be taken annually.

You qualify as being disabled. Certain physical and mental conditions, generally determined by a physician to limit activity, may excuse an individual from the penalty tax.

You are paying medical insurance premiums due to unemployment. If you lost your job, and received unemployment compensation for 12 consecutive weeks, you may take distributions from your IRA account, penalty free, during the year in which you received unemployment compensation, or in the following year, but no later than 60 days after you have been re-employed. Distributions may not exceed the amount paid in medical premiums for you, your spouse, and your dependents.

You are paying for higher education expenses, such as tuition, fees, and books at an eligible educational institution (generally all accredited postsecondary institutions). The distributions may not exceed your qualified education expenses, or those of your spouse, your children, or your grandchildren.

The distribution is attributable to an IRS levy of the IRA. IRAs are strictly regulated to ensure that they are used as vehicles for retirement savings. Therefore, they generally work best as long-term savings vehicles. However, if you do need income from your IRA before you reach age 59 1⁄2, it is important to know if your situation excuses you from the penalty tax levied on early distributions. Playing by the rules may save you money and help preserve your savings for retirement. Be sure to contact your personal tax advisor for assistance.

The information contained in this newsletter is for general use, and while we believe all information to be reliable and ac- curate, it is important to remember individual situations may be entirely different. The information provided is not written or intended as tax, legal, or financial advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us or a solicitation of the purchase or sale of any securities. This article is reprinted with permission from LIBERTY PUBLISHING, INC., BEVERLY, MA COPY- RIGHT 2010.