Structuring IRA Distributions To Avoid Penalties - Safe Harbor Planning: Several Helpful Methods

IRA distribution rules are a mine field. One incorrect move and you could discover yourself faced with high taxes and penalties that can wipe out years of savings and investment. Complicating matters is the Darwinian evolution of IRAs which have taken place since the pioneer IRA was launched in '74 with the enactment of the Worker Retirement Income Security Act (ERISA ). Since '74, IRA policy have altered dramatically and legislation was enacted to severely punish those who don't follow the policy, to the letter of the regulation. IRAs come in several flavors but, for reasons of this article we'll focus on the 2 key types of IRAs: Traditional IRAs and Roth IRAs.

Strategies for Minimizing Penalties on Early Distributions

Usually, any distribution from an IRA before you reach age 59 1/2 is considered as an early distribution and is matter of a 10 percent penalty on the taxable quantity received in a distribution. There're particular IRA distribution rules that might be used to avoid the imposition of this early withdrawal penalty.

1. Using IRA Money to Purchase or Construct Your First House - As much as $10,000 might be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to purchase, construct or rebuild a first home for yourself, your wife, you or your spouse's kid, you or your spouse's grandchild or you or your wife's parent or ancestor.

2. Using IRA Funds for Medicinal Costs - Penalty-free early distributions could be made if the money are used to pay unreimbursed medical expenses which exceed 7.5 % of your adjusted total earnings. There's no obligation to itemize deductions to be eligible for this exception.

3. Using IRA Funds for College Costs - Conventional IRAs can be also tapped to aid fund university expenses; however, the taxable amount of the distributions from these IRAs shall be matter of income tax in the year of the distribution.

Roth IRA distribution rules

Roth IRAs have unique regulations with respect to distributions. Contributions withdrawn are not subject to the 10% penalty and there's no RMD with Roth IRAs. So as for Roth IRA earnings distributions to be tax-free, the account should have been opened for 5 years and the distributions should be made after reaching age 59 1/2. If you fullfil the 5-year rule but not the 59 1/2 year rule, distributions in excess of your contributions will be taxable and matter of a 10% penalty.

1. No RMD - With Roth IRAs, there's no RMD at age 70 1/2. This means a Roth IRA operator is never needed to make a distribution out of their Roth IRA. Because of this, Roth IRAs can grow, untaxed, throughout the lifetime of the owner, allowing a larger legacy for their beneficiaries.

2. Zero Percent Effective Tax Rate - Qualified distributions from Roth IRAs are not matter of income tax...ever. This means you're unaffected by future tax increases as your effective tax rate is constantly the same...zero.

3. Conversion Chances - Beginning after January 1, 2010 anybody, irrespective of their earnings level, may convert conventional IRAs into Roth IRAs. The tax on the taxable income for 2010 conversions can be delayed into 2011 and 2012. If you do not have enough money set aside to do a 100% conversion you can do partial conversions.

4. School Expenses - As Roth IRA contributions might be withdrawn, tax-free, penalty-free, at any time, this kind of contributions can be a tax-free future funding source for your child's university expenses.

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