Structuring IRA Distributions To Avoid Penalties - Protected Harbor Planning: Several Helpful Techniques

IRA distribution rules are a mine field. One wrong move and you could find yourself faced with high taxes and penalties that may wipe out years of savings and investment. Complicating matters is the Darwinian evolution of IRAs which have taken place since the pioneer IRA was introduced in 1974 with the enactment of the Employee Retirement Income Security Act (ERISA ). Since 1974, IRA rules have changed dramatically and laws was enacted to severely punish those who don't follow the policy, to the letter of the rule. IRAs come in many flavors but, for purposes of this article we'll focus on the two chief types of IRAs: Traditional IRAs and Roth IRAs.

Approaches for Minimizing Penalties on Early Distributions

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

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 Using IRA Funds to Purchase or Construct Your First Home - As much as $10,000 may be withdrawn from an IRA as an early distribution penalty-free, so long as the distribution is used to buy, construct or rebuild a first home for yourself, your spouse, you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

2. Using IRA Funds for Medical Bills - Penalty-free early distributions could be made if the money are used to pay unreimbursed medicinal costs which exceed 7.5 % of your adjusted total income. There is no obligation to itemize deductions to qualify for this exception.

3. Using IRA Funds for School Expenses - Conventional IRAs can also be tapped to aid fund college expenses; however, the taxable amount of the distributions from these IRAs will 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 Contributions withdrawn are not subject to the 10% penalty and there's no RMD with Roth IRAs. In order for Roth IRA earnings distributions to be tax-free, the account should have been opened for five 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 owner is never needed to make a distribution out of their Roth IRA. As a result, Roth IRAs can grow, untaxed, during 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 Opportunities - 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 don't have sufficient money set aside to do a 100% conversion you can do partial conversions.

4. School Costs - Because Roth IRA contributions might be withdrawn, tax-free, penalty-free, at any time, such contributions can be a tax-free future funding source for your child's academy expenses.

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