An individual retirement account (IRA) is an important savings vehicle that allows individuals to make pre tax contributions into their own investment portfolio. There are annual contribution and household income limits to determine your investment for the given year. The contributions can be deducted on your taxes and the investments in the account grow tax-free until you make mandatory withdrawals from the portfolio.
IRAs have been around since 1974 and can assist your cash flow in retirement along with your Social Security and/or pensions that you might have. There are many advantages of establishing an IRA, but individuals must avoid withdrawal mistakes that can create huge tax bills and penalties. Here a few points for you to consider:
- Required Minimum Distributions (RMDs): When you reach the age of 70½ you must make mandatory withdrawals from your IRA account. Your IRA custodian will calculate the amount needed for your annual withdrawal and you have the entire calendar year to administer those funds out of the account. If you fail to withdraw the amount required the IRS will impose a 50% penalty on the amount not taken, which is a pretty steep punishment. If you have multiple IRA accounts through various investment or brokerage custodians, you must add the entire total of your RMDs and either take the entire amount from one account or any combination to satisfy your RMD for the year.
- Divorce: When IRAs need to split due to a divorce, the spouse receiving the assets should maintain the tax advantage status of the IRA via a tax- free direct transfer into their own IRA. If one spouse were to receive the funds directly, without implementing the direct transfer route, a 10% penalty would be applied if the individual were under the age of 59½ and the amount taken would be a taxable event, which can create a sizable tax liability. Proper planning can avoid this issue.
- 72(t) distributions: There is a 10% penalty if you were to withdraw funds from your IRA account before 59½. But, 72(t) distributions are a series of withdrawals prior to 59 ½ that will bypass the penalty. According to Investopedia, the Internal Revenue Code sections 72(t) and 72(q) allow for penalty-free early withdrawals from retirement accounts. You must make a series of equal payments from your IRA for at least five years or until 59½, whichever period is longer. There are several conditions that must be met and the distributions must be consistent. You can also not modify the agreed schedule for these payments. If you do violate the agreement a 10% penalty will take place to all distributions taken prior to age 59½. And remember, any distributions you take will be added to your income for the year. Be aware of this, since the withdrawals you take may push you into a higher tax bracket.
- Hardship withdrawals: Some company retirement plans allow employees the capability to access their 401(k) funds to help with a financial emergency. Investopedia provided a list of the withdrawals that are taxable and impose a 10% penalty; if you are under 59½, they are limited to certain medical expenses, purchase of your main home, tuition and educational expenses and payments to prevent foreclosure on your home, to name a few. But, if you withdraw from your IRA account for the any reason and roll back the funds that you withdrew within 60 days, you will avoid the 10% penalty. The rule allows you to receive the distribution, make use of the funds for a period of 60 days, and then redeposit the funds into your IRA without any tax consequences. You are only allowed to do this 60 day rollover once per year, and the responsibility is on the individual to make sure the rollover occurs within 60 days.
Please consult with your tax and financial advisor when making withdrawals from your IRA. It can save a major headache down the road.