IRA Withdrawals Can Be Costly
It is received wisdom that the objective behind an IRS is to build that nest egg for the future. Nonetheless, it is not uncommon, especially in the wake of recession, for many taxpayers to tap into this money to help sustain themselves. Unfortunately, early IRA withdrawals carry severe tax penalties. While tax professionals like CPAs and enrolled agents understand the tax implications of IRA withdrawals, taxpayers are often oblivious to these implications, a reality that underscores the value of seeking advise from a registered tax agent before considering such a move.
Below are some of the more pertinent facts around IRA withdrawals that tax professionals will encounter in most standard tax CPE courses. These facts and tips should be part of any obligatory conversation between tax professional and client who is investing in IRAs.
What is Considered an Early IRA Withdrawal?
Any withdrawal from an IRA before the age of 59 and Aï¿½ is considered an early withdrawal, and will result in tax penalties. However, once a taxpayer turns 59 and 1/2, they are entitled to an unlimited number of withdrawals penalty-free until the age of 70 and Aï¿½. At this age, penalties kick-in once again.
Taxes and Penalties
Unless taxpayers qualify for a special exemption, each early withdrawal is subject to a 10% tax penalty. In addition to that flat penalty, they are required to pay income taxes on the money withdrawn from the IRA.
There is a silver lining. This comes in the form of tax laws that entitle taxpayers with IRAs to penalty-free withdrawals in certain situations. These instances are known as qualified distributions, and were envisioned as a way of assisting taxpayers confronting special financial situations. If a taxpayer’s Roth IRA has been open at least five years, distributions can be taken both penalty and tax-free.
Below are the various options for taking a qualified distribution available to IRA holders.
Most withdrawals made for medical expenses are subject to all penalties and fines with one exception: If the amount of medical expenses paid by a taxpayer exceeds 7.5% of the adjusted gross income, IRA withdrawals may be penalty free.
Early withdrawals used to cover higher education expenses are not taxed.
Unemployment Health Care
Taxpayers receiving unemployment payments for 12 weeks or more, and who may need money to offset health insurance premiums, are eligible a special exemption.
Active Military Exemption
A military reservist who has been active for 180 days can make early IRA withdrawals without incurring any IRS penalties.
Account holders who are mentally or physically disabled, and, as a result, are unable to sustain a job or conduct business, can take qualified distributions, but the disability must be long-term.
Withdrawals by an account holder’s beneficiary after their death are exempt from the penalty tax.
First-time homebuyers are permitted to withdraw up to $10,000 from an IRA penalty-free. The IRS defines first-time homebuyer as a taxpayer who has not owned a home in the past 3 years.
If the event that IRS withdraws money from a taxpayer’s IRA to pay a tax levy, the 10% penalty is not applied.
Given the sheer number of applicable scenarios, it is always wise for taxpayers to consult an IRS enrolled agent or CPA before taking an early IRA withdrawal. This could end up saving them a bundle.
Substantially Equal Periodic Payments
One alternative to searching for qualified distributions (a topic often covered in most tax continuing education courses) is taking Substantially Equal Periodic Payments (SEPPs). This option allows taxpayers to take periodic payments from an IRA without having to pay any penalty.
IRS Circular 230 Disclosure
Pursuant to the requirements of the Internal Revenue Service Circular 230, we inform you that, to the extent any advice relating to a Federal tax issue is contained in this communication, including in any attachments, it was not written or intended to be used, and cannot be used, for the purpose of (a) avoiding any tax related penalties that may be imposed on you or any other person under the Internal Revenue Code, or (b) promoting, marketing or recommending to another person any transaction or matter addressed in this communication.