IRA Withdrawals

This article is going to cover the topic of IRA withdrawals.  Here we're going to summarize the withdrawal or distribution rules that apply to traditional IRAs, Roth IRAs and SIMPLE IRAs.  We're going to talk about normal withdrawals (or qualifying distributions), minimum required distributions, exceptions to these withdrawal rules, and possible income tax penalties.

IRA Distributions and Withdrawals

In the following sections we're going to use the words distribution and withdrawal interchangeably.  For the most part, IRA holders believe they are making withdrawals from their account, while in the "technical" world, the IRS considers these distributions.

Traditional IRA Withdrawal Rules

All withdrawals from a traditional IRA before age 59 1/2 are considered early withdrawals.  If you take an early withdrawal from your traditional IRA, then in addition to any regular federal income or state income tax due on the withdrawal, you also need to pay an additional 10% tax penalty.

Minimum Required Distributions or MRD

In addition to the standard withdrawal rule mentioned above, traditional IRAs also have a minimum required distribution rule.  The MRD begins when the holder of a traditional IRA reaches age 70 1/2.  The intention of this withdrawal rule is to make sure that retirement money sitting in a traditional IRA is methodically removed from that account (and taxes paid) over the remaining expected lifespan of the account holder.

The specific MDR requirements steps include:

1. You must begin to start receiving minimum distributions from your traditional IRA by April 1st of the year following the year you reach age 70 1/2.  This is referred to as the beginning date.
2. Starting with your beginning date, you must receive at least the minimum required amount each year starting with the year you reach age 70 1/2.  If you don't withdraw that minimum in the year your turned 70 1/2, then you must receive a minimum distribution for your 70 1/2 year by April 1st of the following year.
3. The required minimum required distribution for any year after the year you turn 701/2 must be made by December 31st of that later year.

Remember, the intention here is to try and disburse the money over your expected remaining lifespan.  So even if you started receiving distributions from your IRA before age 70 1/2, you still need to start calculating your required MRD by the beginning date mentioned earlier.

And even if you've received more than the required distribution in any year, you don't take a "credit" on your remaining IRA account balance when calculating your MDR in future years.

IRA Early Withdrawal Exceptions

Earlier we mentioned that there were exceptions to the age 59 1/2 rule.  In reality everyone that owns an IRA can take a withdrawal before the age 59 1/2 and not have to pay the 10% tax penalty.  That's right; everyone qualifies for penalty-free IRA withdrawals provided they take the money out in a certain fashion or for a certain reason.  Let's take a closer look at how that can happen.

There are a total of eight exceptions to the age 59 1/2 rule that are outlined by the IRS:

• Unreimbursed Medical Expenses - If your medical expenses are more than 7.5% of your adjusted gross income for that year, then you are allowed to take an IRA withdrawal without paying the 10% tax penalty.
• Medical Insurance - If you lost your job, received unemployment compensation and paid for medical insurance for yourself, your wife and your dependents, then you might be able to withdraw from your IRA the amount you paid for the insurance provided you did not receive the distribution more than 60 days after finding a job.
• Disability - If a physician determines that you are unable to do any substantial gainful activity due to physical or mental conditions, then you can make withdrawals that are not subject to the 10% tax penalty.
• Beneficiary of an IRA - If you were to expire before reaching age 59 1/2, then your IRA can be distributed to your beneficiaries or estate free from the early withdrawal tax penalty.
• Higher Education Expenses - If you paid expenses for higher education during the year, part (or all) of any distribution may not be subject to the 10% tax penalty.
• First Time Homeowner - You can make an early withdrawal from an IRA if you use the money to purchase, rebuild or build your first home.  The distributions are limited to $10,000 and must be withdrawn no more than 120 days after making the purchase.
• Rollover into another Qualified Plan - If the withdrawal is rolled over into another qualifying IRA plan in a timely manner, then it is not subject to the 10% early withdrawal penalty.

This final rule is an interesting one.  It seems that the IRS did not want to really deny anyone access to their retirement money, as long as the money was truly going to be used for retirement.  This is the basis for this final IRS withdrawal rule, and it is an early withdrawal that anyone can make without a penalty provided they follow the rules:

• Annuity Distributions - Withdrawals can be made from a traditional IRA that is part of a series of substantially equal withdrawals that will occur over your lifetime. You must use an IRS approved method to calculate these withdrawals.  These equal payments must continue for at least 5 years or until age 59 1/2, whichever is later.  That means if you start these withdrawals at age 57, they must stay the same until age 62.  There is a one-time switch you can make to this process as far as the amount withdrawn is concerned.

With any of these eight exceptions it is best to seek the advice of a tax professional.  Remember that you started the IRA for your retirement and, if you can, you should keep it for that purpose.  If you need the money, at least you can be assured access to it - penalty-free.

Roth IRA Withdrawal Rules

In general, you can take a distribution from your Roth IRA once you've reached age 59 1/2 and after the 5-taxable-year period (which starts with the first year you made a contribution to a Roth IRA) has passed.  Unlike a traditional IRA, you're not required to take a minimum required distribution from a Roth IRA.

If you make a withdrawal that is not considered a qualified distribution, then the money may be taxed as ordinary income and subject to the additional 10% early withdrawal penalty.  Even if a contribution had been included in taxable income in earlier years, a distribution before the 5- taxable-year period expires on a Roth conversion may be subject to this 10% penalty.

Roth IRA Early Withdrawal Exceptions

Just like the traditional IRA, there are three exceptions to the early withdrawal rules that apply to Roth IRAs mentioned above.

• Beneficiary of an IRA - If you were to expire before reaching age 59 1/2, then your Roth IRA can be distributed to your beneficiaries or estate free from the early withdrawal tax penalty.
• Disability - If a physician determines that you are unable to do any substantial gainful activity due to physical or mental conditions, then you can make withdrawals that are not subject to the 10% tax penalty.
• First Time Homeowner - You can make an early withdrawal from a Roth IRA if you use the money to purchase, rebuild or build your first home. Qualified costs include the main home of a first time home buyer who is yourself, your spouse, your children, grandchildren, a parent, or another ancestor.

SIMPLE IRA Withdrawal Rules

In general, an employer cannot require an employee to keep any portion of their contributions in their SIMPLE IRA.  Employers are also not allowed to introduce any plan-specific withdrawal rules.

SIMPLE IRA Withdrawal Exceptions

SIMPLE IRAs follow the same withdrawal rules that apply to traditional IRAs - including exceptions.  But there is also a rule that is called the "2-year period" rule that is unique to SIMPLE IRAs.

The 2-year period begins on the date on which the employee first participated in any SIMPLE IRA plan maintained by their employer.  If an employee takes an early distribution within this 2-year period, then the additional tax penalty is raised from 10% to 25%.  However, if one of the exceptions mentioned earlier applies to these early withdrawals then the 25% tax penalty is not imposed.

About the Author - IRA Withdrawals

Copyright © 2004 - 2007 Money-Zine.com

Retirement Resources on the Web