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When You Have to Tap the IRA

All the rules and the pundits tell you: don’t take money out of your IRA before you retire. This stash of cash, invested carefully, should grow steadily until you have entered retirement. And then you can withdraw the money on a steady but careful basis to pay for an enjoyable lifestyle.

These rules need some rethinking. With your employment in uncertainty, and  the student loan payments  piling up for your children who moved back home because they can’t get a job, and the  funds you need to hire some caregivers for your aging and ill parents, you are hard pressed.  There may be no choice but to take money you need  from the IRAs years before you had planned to tap it.

Here are some approaches to help you get access to the money without hefty extra taxes. The basic rule is that you can withdraw money from an IRA when you are age 59 1/2, and the money will be counted as ordinary income for tax purposes. But if you are younger than  59  1/2, you will pay taxes, PLUS a 10% penalty.

You can withdraw the money from an IRA, pay regular income taxes, without the 10% penalty, if you:

Leave a job at age 55 and roll your 401(k) account into an IRA.

Use  the money to pay for education expenses for yourself, your spouse, your children, or your grandchildren.  The money can be used at any college, university, vocational school that is accredited and meets the standards for federal student aid.  The money can be used to pay for room and board ,   tuition, books and student fees

Are unemployed for 12 weeks or more, and use the money to pay for your health insurance.

Have medical expenses in excess of 7.5% of your adjusted gross income.  Let’s say you had an adjusted gross income of $80,000, and medical expenses (health insurance premiums, co-payments and deductibles and drug costs, and other health care  bills) of  $12,500 last year. You can use your IRA to pay  $6,500 of your medical bills.  You can do this even if you don’t itemize deductions on your federal tax bill.

Were called up from the reserves for military duty and served for more than 180 days since September 11, 2001.

Are a first-time home buyer. This one is a bit complex. The government says a first time buyer is someone who hasn’t owned a home for two years. If you were a homeowner for many years, then sold and rented for the past two years, you qualify as a first-time owner. You can use the money to buy a home for yourself, spouse, children or grandchildren.

There is a $10,000 lifetime limit on the money you can withdraw without penalty when you buy a house. And you have to use the money within 120 days of withdrawing it from the IRA. The cash can be used to purchase or construction or renovation of a home, and for financing or closing costs. This includes the costs of buying, building or rebuilding a home, along with any usual settlement, financing or closing costs.

Younger workers can get money from their  IRAs without penalty under a special IRS program, called substantially equal periodic payments (SEPP).  These payments must be taken out each year for at least five years, or until the individual reaches age 59 1/2, whichever comes later.  For example, someone who is  47  would have to withdraw the money each year for  12 years.  A 57 -year old would have to make the withdrawals until age 62.

Kiplinger’s explains:

“The ’72(t)’ strategy, named for the section of the tax code that sets out exceptions to the early-withdrawal penalty, should be a last resort. Once you start taking distributions, you’re locked in. You can’t make new contributions to the IRA or take additional withdrawals. If you violate any of the rules, you could pay big penalties. ‘The biggest disadvantage of 72(t) is inflexibility,’ says Mike Piershale, a financial adviser in Crystal Lake, Ill. As with typical withdrawals from a traditional IRA,  distributions will be taxed at your ordinary-income tax rate.

The strategy could be useful if you need to supplement your income stream. Kimberly Foss, president of Empyrion Wealth Management, in Roseville, Cal., says a client used these payouts to bridge an income gap. He retired early at 55, but his pension didn’t kick in until age 60.”

IRS has a list of frequently asked questions on the 72t withdrawal policy.





Written by Bob Rosenblatt

Bob Rosenblatt is a researcher, writer and journalist who helps people looking for up-to-date answers and information on the perplexing issues at the intersection of finances and aging. Bob publishes a weekly report — please take a moment to subscribe in the upper right hand corner of this page.

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