Early
Withdrawals From Individual Retirement Accounts
This letter is intended to respond to several inquiries regarding the extent to
which contributions to Individual Retirement (IRA) Plans may be withdrawn for
certain emergencies before retirement age. The exceptions to the no-withdrawal
rule explained in this correspondence are broad and all of them may not apply
to you but are presented here for the sake of completeness.
First of all, an individual may withdraw
money from an IRA at any time. However, withdrawals will trigger income tax
liability of the amount withdrawn (except for some Roth IRA's) and a 10%
penalty tax unless an exception-to-the-rule is met. From an investment point of
view, funds from an IRA should be the last nest egg you touch unless the 10%
penalty tax can be avoided.
Withdrawals from traditional IRA's and Roth
IRA's are taxed differently since the 10% penalty only applies to the portion
of the distribution subject to income tax (except for amounts attributable to
Roth conversions within five years):
· For a traditional IRA, distributions are
treated as coming ratably from contributions and earnings. Only the portion of
a distribution attributable to nondeductible contributions is not taxed, while
the portion of the distribution attributable to deductible contributions is
treated the same as earnings.
· For a Roth IRA, distributions are first
deemed to be paid out of contributions, which are nondeductible (or already
taxed in the case of a rollover situation). Therefore, substantial withdrawals
may be made for any reason from Roth IRA's without tax or penalty.
The exceptions: the 10% penalty will not be
assessed on an IRA distribution to the extent that any of the following
exceptions apply:
· On or after reaching age 59 ½ by the IRA
owner (traditional or Roth IRA; also exempt from income in Roth IRA).
· On or after the death of the IRA owner (traditional or Roth IRA; also exempt
from income in Roth IRA).
· After disability of the IRA owner (traditional or Roth IRA; also exempt from
income in Roth IRA).
· Qualified first-time homebuyers up to $10,000 (traditional or Roth IRA; also
exempt from income in Roth
IRA).
· Qualified higher education expenses (traditional or Roth IRA).
· Deductible medical expenses (traditional or Roth IRA).
· Health insurance premium distributions to certain unemployed owners
(traditional or Roth IRA).
· A series of substantially equal periodic payments, made at least annually, to
a traditional IRA owner (inapplicable to Roth IRA's).
· Distribution incident to a divorce of a traditional IRA owner made to an
alternate payee made under a qualified domestic relations order.
The general rule of thumb on IRA withdrawals
is that a taxpayer should contribute in the first place only those funds that
he or she will not touch under any circumstances. However, if emergencies arise,
at least it will be up to you, rather than Uncle Sam, to make the decision on
the trade off between keeping funds for retirement and using them for certain
other important lifetime events.
If you have any further questions on IRA
withdrawals, please do not hesitate to call.
