Benefiting Substantially From Your IRA Early
If you own an Individual Retirement Account (IRA), the primary purpose is to
accumulate assets to provide an income source during retirement. In the
accumulation phase, you may contribute to an IRA on a tax deductible basis (with
some exceptions) with the earnings growing tax deferred.
Upon withdrawal, distributions will be included in income and taxed
accordingly. In addition, for those wishing to access their IRAs "early,"
distributions prior to age 59 ½ will be subject to a 10% premature distribution
penalty tax, unless an exception applies.
You may have thought that there is no way to withdraw funds from your IRA
"early", before age 59 ½, and avoid the 10% penalty. This is not true. The IRS
permits an individual, under the age to 59 ½, to make distributions from their
IRA and avoid the 10% early withdrawal penalty if the distributions are due to
one of the IRS exceptions, one of which is a series of substantially equal
periodic payments. As you may have guessed, there are several requirements that
apply when claiming the substantially equal payment exception.
For example, once distributions are deemed to have begun from the IRA under
the substantially equal payment exception, the payments must continue at least
annually, unmodified, for the longer of five years or until the IRA participant
reaches age 59 ½.
In other words, if a 50 year old IRA participant begins distributions under
this exception, distributions must continue until the individual attains age 59
½ before the amount could be modified. On the other hand, if a 58 year old IRA
participant begins distributions under this exception, distributions must
continue until the individual attains age 62 before the amount could be
modified.
The amount that can be withdrawn each year is calculated by using one of
three IRS approved methods: annuity, amortization and life expectancy. The
variables included in the calculation are the individual's age, the IRA account
value and a "reasonable" interest rate.
Each method will allow a different amount to be withdrawn from your IRA and
most individuals simply choose the method allowing for the distribution amount
closest to what they need. Generally, a tax or financial advisor with the use of
software can perform these calculations for you.
The substantially equal payment exception does allow for you to access your
IRA "early" but is it the best alternative? It is important to note that if the
payment amount is modified before the later of five years or attainment of age
59 ½, a 10% penalty will be applied retroactively to all current and previous
distributions intended to qualify under the substantially equal payment
exception.
Before electing substantially equal payments from the IRA, ask yourself, will
I be able to maintain the amount withdrawn for the necessary time period?
Consider the use of this method in difficult financial times. If you have been
temporarily unemployed, the amount of the payment may not be sufficient to
sustain your lifestyle during a prolonged work stoppage.
Individuals applying this strategy have been known to dip back into the IRA
for more money, thus modifying the payment schedule and subjecting all
distributions to the retroactive 10% penalty.
This article illustrates just a few of the many issues to consider before
beginning a series of substantially equal payments from your IRA. These issues
and alternative solutions should be carefully examined with your financial
advisor or tax professional before making any decisions.
