The Individual Retirement Account (IRA) is one of most popular methods of saving money for retirement. Backed by attractive tax incentives, the IRA is a precious tool for accruing retirement savings. But after many years of putting money into an IRA, the time to stop saving and begin withdrawing money from the investment account eventually comes. When that time arrives, the withdrawal can either be in the form of cash or assets and is referred to as IRA distribution.
What Are IRA Distributions?
Cash and In-Kind
There are two major types of IRA distributions: cash and in-kind. With cash distributions, IRA account holders request that all or part of the cash in their accounts be distributed from their accounts and sent to them via check, ACH or direct wire transfer. The account holders then take personal possession of the cash.
What are IRA distributions? But in in-kind (asset) distributions, IRA account holders request that IRA assets be distributed from their accounts without actual sale of the assets. The account holders then take ownership of the distributed assets. In-kind distribution is common when dealing with liquid assets such as private stock or real estate, especially when account holders have to take the Required Minimum Distributions (RMD). During asset distribution, the asset’s fair market value is used to work out the equivalent dollar value.
When Can You Make Early Distributions from Traditional IRA?
Money can be withdrawn from an IRA at any time as long as the rules are followed. The best-known IRA rule is that taking money out too early results in a penalty. In fact, to make penalty-free IRA distributions, individuals must have attained the age of 59 1/2. What are IRA distributions? Therefore, retirees can generally make early withdrawals as long as they are willing to cover the 10% IRS penalty on top of any tax liabilities they owe from their traditional IRA withdrawals, which get added to their taxable income for the year.
Nevertheless, there are a number of exceptions that can be explored to avoid the 10% penalty associated with the 59 1/2 rule. For instance, there are typically no penalties on up to $10,000 worth of distributions made to pay for first-time home purchases, qualified educational expenses (for yourself or family members), health insurance payments for unemployed IRA investors, and un-reimbursed medical expenses. What are IRA distributions? Similarly, IRA investors can avoid the 10% penalty if they withdraw money to run programs of substantially equal periodic payments (SEPPs). However, the SEPP plans can only be used for penalty-free early withdrawals if they last for a minimum of 5 years and have no provisions for penalty-free cancellation.
Making Early Distributions from Roth IRAs
Roth IRAs provide more flexibility than traditional IRAs. Usually, individual investors can make withdrawals from Roth IRAs penalty-free any time and for any reason, as long as they do not withdraw any earnings on their investments or amounts converted from traditional IRAs before they attain the age of 59 /12. Withdrawing earnings or converted amounts attract a 10% penalty. Distributions from Roth IRAs are viewed in the following order: investor contributions then money converted from Traditional IRAs before earnings. Hence, to make early penalty-free Roth IRA distributions, retirees need to know how much they have contributed and only withdraw their contributions because making deeper withdrawals can affect conversions or earnings, resulting in penalties and taxation.
Making Qualified IRA Distributions
For those who have attained the magic age of 59 1/2 or older, IRA withdrawals can be made without penalties. Such cash or asset withdrawals are called “qualified distributions”. And when the qualified distributions are made from traditional IRAs, retirees must pay income tax. What are IRA distributions? On the contrary, qualified distributions from Roth IRAs are income tax-free but can only be made after 5 years since the first contribution. Likewise, investors who have converted regular IRAs to Roth IRAs cannot make withdrawals without penalties unless they wait for a minimum of 5 years after conversion.
Moreover, for traditional IRAs, distributions have to be taken once the retiree reaches the age of 70 1/2. What are IRA distributions? These mandatory withdrawals are called Required Minimum Distributions (RMDs). To calculate how much minimum distribution you have to take, just take your IRA balance ( at the end of the previous year) and divide it by the life-expectancy number (obtained from IRS chart). The result is the RMD for the year and failure to withdraw at least that amount will result in a 50% penalty on the RMD.
To avoid this penalty, investors should get started on withdrawing at least the minimum amount as soon as necessary. Alternatively, investors can convert their traditional IRAs to Roth IRAs to avoid making these compulsory minimum withdrawals because Roth IRAs do not have RMD provisions and money can be left in the investment account as long as desired by retirees throughout their lifetime.
Following are a few helpful what are IRA distributions links:
The above information is not intended to substitute specific individualized tax, investment or legal planning advice. Where you need specific advice, please consider consulting with a professionally qualified and certified investment manager, financial planner, CPA or tax advisor.