IRA Payout Rules

by D. Laverne O'Neal

Individual Retirement Arrangements offer tax advantages to encourage working Americans to save for retirement. The traditional IRA imposes restrictions on payouts, or distributions, of both principal and interest, in addition to requiring mandatory withdrawals after a certain age. Roth IRAs also carry restrictions but the rules on withdrawing contributions are more lenient.

Traditional IRA Distributions Taxable

You pay taxes on money as you make withdrawals from your IRA.

Because traditional IRA contributions are tax-deductible, withdrawals are subject to ordinary income tax. The IRS taxes the distribution at whatever tax rate applies to you during the tax year. You report the distribution and pay the tax when you file your tax return. This makes timing your withdrawals something to consider. Perfectly legal strategies can be used to minimize the tax you owe on distributions from an IRA. Consult the IRS tax rate table, available online or in print, to find out whether a distribution will push you into a higher tax bracket for that year. You may want to divide the amount of the withdrawal to avoid being taxed at a higher rate. For example, after age 59 1/2, you want to withdraw $10,000 from your IRA, but you discover that doing this in a single tax year will push you into a higher bracket. Taking out $5,000 at the end of one tax year and another $5,000 at the start of the next may help you avoid the increased tax rate.

Traditional IRA: Required Minimum Distributions

Calculating your RMD requires consulting an IRS life-expectancy table.

By April 1 of the year after a traditional IRA owner turns 70 1/2, he must begin taking required minimum distributions (RMDs) from the account. The amount of the distribution depends on the account owner's age, marital status and tax-filing status. If the RMD is less than the amount required, or if it is not distributed timely (by the last day of the calendar year), the Internal Revenue Service will assess a 50 percent penalty tax on the amount that should have been withdrawn but was left in the IRA. To calculate the RMD for a given year, divide the IRA balance as of December 31 of the previous year by the figure corresponding to your age in the IRS life expectancy table that applies to your circumstances. Life expectancy tables are published on the IRS.gov website and in the print version of IRS Publication 590. If you are single or your spouse is younger than you by 10 years or less, use the Uniform Lifetime Table. The same table applies if your spouse is not your sole IRA beneficiary. If your spouse is more than 10 years your junior, use the Joint and Last Survivor Table. IRA beneficiaries consult the Single Life Expectancy Table. For example, you are single, age 72 and your IRA balance at the end of the previous year was $200,000. Your RMD equation is 200,000 divided by 25.6, which equals $7,812.50. You have to calculate your RMD each year, as the age-related divisor changes each year.

Age 59 1/2 Rule

You can start withdrawing money from your traditional IRA without penalty when you reach age 59 1/2. If you take distributions any sooner, unless the reason for the distribution qualifies for an IRS exception, you will have to pay an early withdrawal excise, or penalty, tax of 10 percent on the amount of the withdrawal, in addition to ordinary income tax.

First-Time Homeowner Exception

Buying a house can help you avoid the early withdrawal penalty.

You can withdraw up to $10,000 in your lifetime to pay for the purchase or construction of a first home. The home must be a primary residence for you, your spouse, your children and grandchildren, or your parent or other ancestor. Even settlement, financing or closing costs can be covered with the IRA money. A first-time homebuyer is defined by the IRS as a person who has not owned a primary residence for two years. Your spouse must also meet this requirement. Take care over the timing of your IRA withdrawal – you must use the funds within 120 days of the distribution.

Higher Education Exception

Paying for higher education can help you avoid tax penalties.

You can avoid the 10 percent penalty tax on distributions before age 59 1/2 if you use the funds withdrawn from a traditional IRA to cover the cost of higher education expenses for yourself, your spouse, your children or your grandchildren. Eligible costs include tuition, fees, books, supplies and equipment. The school must be "eligible to participate in the student aid programs administered by the U.S. Department of Education," according to IRS Publication 590.

Disability Exception

You are entitled to withdraw from a traditional IRA without penalty if you can furnish proof from a doctor that "you cannot do any substantial gainful activity because of your physical or mental condition," according to the IRS. The condition must "be expected to result in death or to be of long, continued, and indefinite duration."

Medical Exceptions

Paying medical expenses can save you from the 10 percent excise tax.

If your unreimbursed medical expenses exceed 7.5 percent of your gross income, you can use traditional IRA funds to cover them. You will not have to pay the 10 percent excise tax on the withdrawal. Further, if you become unemployed and collect federal unemployment benefits for at least 12 consecutive weeks, you can withdraw traditional IRA monies penalty-free to pay health insurance premiums for yourself, your spouse and your dependents

Roth IRA Contribution Withdrawals

You can freely access Roth IRA contributions.

Contributions to a Roth IRA can be withdrawn at any time, tax-free and penalty-free, but earnings on those contributions are subject to restrictions. There is no RMD for a Roth account. In addition, you can continue contributing to a Roth for as long as you live.

Roth IRA Five-Year Rule

Keep a close eye on the calendar to comply with the Five-Year rule.

If you have owned a Roth IRA for at least five years, you can take out earnings penalty-free only if you have reached age 59 1/2, have become disabled or are using the money to buy a first home. In every other case, you will have to pay a 10 percent excise tax on the earnings withdrawal. The five-year period begins January 1 of the year in which you first opened your first Roth IRA. For example, if you open a Roth IRA on October 31, 2012, the five-year clock begins January 1, 2012. The start of the five-year period is static, no matter when and whether you open additional Roth accounts. Continuing with the example, after opening your first Roth in October 2012, you open another in April 2014 and a third in November 2016. The start of the five-year clock for all the Roth accounts remains at January 1, 2012.

About the Author

D. Laverne O'Neal, an Ivy League graduate, published her first article in 1997. A former theater, dance and music critic for such publications as the "Oakland Tribune" and Gannett Newspapers, she started her Web-writing career during the dot-com heyday. O'Neal also translates and edits French and Spanish. Her strongest interests are the performing arts, design, food, health, personal finance and personal growth.

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