FCW's Friday Financials column spells out ways to avoid penalty for early withdrawal of individual retirement account funds
If you have been thinking about withdrawing money from an IRA or other tax-deferred
retirement plan prior to age 59 1/2, try to hold off if you can. But if
you decide that you have no choice, make sure you know what the rules are.
Withdrawals made before age 59 1/2 from an individual retirement account
or other tax-deferred plan are subject to a 10 percent penalty tax, with
the following exceptions:
* Distributions are made to a beneficiary (or to the estate of the employee)
on or after the death of the employee.
* Distributions are made to a disabled employee.
* Distributions are part of a series of substantially equal periodic payments
(no more than once per year) made during the life or life expectancy of
the employee or the joint lives or joint life expectancies of the employee
and his/her designated beneficiary.
This last provision is not well-known. Here's how it works: An employee
who is 53 years old with a life expectancy of 30 years can start taking
penalty-free IRA distributions of 1/30th the value of the IRA beginning
at age 53.
There are several ways to calculate what constitutes "substantially equal
periodic payments." For example, it is all right to recalculate the amount
each year based on your life expectancy at that time and your IRA balance.
The Internal Revenue Service publishes life expectancy tables that can help
with those calculations. Once you start making withdrawals, you must continue
them until you reach age 59 1/2 or five years have passed, whichever occurs
later to avoid the penalty.
Other exceptions include:
* Thrift Savings Plan distributions made to an employee who leaves his or
her government job after age 55. However, if you roll over your TSP plan
assets to an IRA, you must wait until age 59 1/2 before penalty-free withdrawals
* Emergency withdrawals made by an employee that are used to pay medical
expenses, regardless of whether the employee itemizes medical expenses on
his or her tax return. Distributions made to an alternate payee, to your
ex-spouse, for example, under a domestic relations court order.
* Early distributions from an IRA to unemployed individuals who use the
money to pay their health insurance premiums. However, being unemployed
does not allow you to make early IRA withdrawals for any reason whatsoever.
Early penalty-free IRA withdrawals must be used pay for your health insurance
* Early IRA withdrawals to buy a home by first-time homebuyers, with a $10,000
lifetime limit. A withdrawal must be used within 120 days after the day
on which the payment or distribution is received. The first-time homebuyer
can be you, your spouse or any child, grandchild and an ancestor of yours
or your spouse. You can use the money for acquiring, constructing, or reconstructing
a residence, as well as paying for usual or reasonable settlement, financing
or other closing costs.
* IRA withdrawals to pay for an employee's higher education expenses or
those of his or her immediate family.
* Tax-free rollovers such as from one IRA to another or from one employer
plan to another. It is best to roll over money from one plan custodian to
another. If the money is sent to you, the custodian must withhold a 20 percent
tax. You can claim this amount on your next tax return, but you must send
the entire account balance to the new custodian within 120 days. If you
cannot come up with the 20 percent that was withheld out of your own pocket,
you are considered to have made an early withdrawal subject to the 10 percent
—Zall, Bureaucratus columnist and a retired federal employee, is a freelance
writer based in Silver Spring, Md. He specializes in taxes, investing, business
and government workplace issues. He is a certified internal auditor and
a registered investment adviser. He can be reached via e-mail at firstname.lastname@example.org.
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