Individual Retirement Accounts, commonly referred to as an IRA, offer tax advantages that allow Americans to save for retirement with tax advantages. But it is crucially important that one understands IRA distribution rules to avoid potential penalties from the IRS; there are strict regulations as to when withdrawals may or may not incur penalty fees.
Know Your Age Requirement (ARR)
Withdrawals from most IRAs usually begin after age 59 1/2; any early withdrawal before this point could incur a 10% early withdrawal penalty and count towards your taxable income.
Age RestrictionsExceptions apply under some circumstances
There are various exceptions whereby you may avoid paying the 10% penalty even if you are under 59 1/2:
First Time Home Purchase: Withdraw up to $10,000 without incurring a penalty when purchasing, building, or renovating your first home.
Higher Education Expenses: Funds may be taken out for qualifying education expenses for yourself, your spouse and/or descendants.
Health Insurance: Unemployed workers of 12 weeks or longer may take distributions in order to pay their health insurance premiums.
Disability: Should your disability prove permanent and you can provide proof, the penalty won’t apply.
Reducing Substantially Equal Periodic Payments (SEPP): With this approach, at least five annual distributions should be taken based on either your life expectancy or that of any beneficiaries involved.
Roth IRAs provide greater withdrawal flexibility. Since contributions are made with post-tax dollars, you are free to withdraw contributions at any time without penalty; earnings however must have been earned within five years (and you be 59 1/2). To withdraw earnings tax-free.
Required Minimum Distributions (RMDs) are an indispensable element of financial risk mitigation strategies.
Once you reach age 72 (or 70 1/2, if born before January 1, 2020) RMDs must begin being withheld from your traditional IRA. Failing to withdraw the full RMD amount may incur a 50% penalty on whatever is not taken out in time.
Beneficiaries and IRAs
When inheriting an IRA, various rules will come into effect that could potentially make life complicated for beneficiaries. While the regulations can be complex, usually beneficiaries can receive distributions over an agreed timeframe or opt for a 10-year plan distribution schedule – therefore making understanding these regulations essential or consulting with a tax advisor imperative.
While not exempt from penalties, some IRAs allow hardship distributions under specific rules and qualifications.
Plan and Document
To take full advantage of one of the exceptions and avoid penalties, be sure to document everything. Keep a detailed accounting of how the money has been distributed just in case the IRS questions its usage.
While an IRA can be an excellent tool for retirement savings, its rules can often be complex and the rules surrounding withdrawals need to be carefully planned before being made – especially if you’re under 59 1/2. Consulting with a professional adviser before withdrawing funds can ensure you use them when needed without incurring penalties that might otherwise apply.