Benefiting Substantially From Your IRA Early
by Ken Morris
If you own an Individual Retirement Account (IRA), the primary
purpose is to accumulate assets to provide an income source
during retirement. In the accumulation phase, you may contribute
to an IRA on a tax deductible basis (with some exceptions) with
the earnings growing tax deferred. Upon withdrawal,
distributions will be included in income and taxed accordingly.
In addition, for those wishing to access their IRAs "early,"
distributions prior to age 59 ½ will be subject to a 10%
premature distribution penalty tax, unless an exception applies.
You may have thought that there is no way to withdraw funds from
your IRA "early", before age 59 ½, and avoid the 10% penalty.
This is not true. The IRS permits an individual, under the age
to 59 ½, to make distributions from their IRA and avoid the 10%
early withdrawal penalty if the distributions are due to one of
the IRS exceptions, one of which is a series of substantially
equal periodic payments. As you may have guessed, there are
several requirements that apply when claiming the substantially
equal payment exception.
For example, once distributions are deemed to have begun from
the IRA under the substantially equal payment exception, the
payments must continue at least annually, unmodified, for the
longer of five years or until the IRA participant reaches age 59
½. In other words, if a 50 year old IRA participant begins
distributions under this exception, distributions must continue
until the individual attains age 59 ½ before the amount could be
modified. On the other hand, if a 58 year old IRA participant
begins distributions under this exception, distributions must
continue until the individual attains age 62 before the amount
could be modified.
The amount that can be withdrawn each year is calculated by
using one of three IRS approved methods: annuity, amortization
and life expectancy. The variables included in the calculation
are the individual's age, the IRA account value and a
"reasonable" interest rate. Each method will allow a different
amount to be withdrawn from your IRA and most individuals simply
choose the method allowing for the distribution amount closest
to what they need. Generally, a tax or financial advisor with
the use of software can perform these calculations for you.
The substantially equal payment exception does allow for you to
access your IRA "early" but is it the best alternative? It is
important to note that if the payment amount is modified before
the later of five years or attainment of age 59 ½, a 10% penalty
will be applied retroactively to all current and previous
distributions intended to qualify under the substantially equal
payment exception. Before electing substantially equal payments
from the IRA, ask yourself, will I be able to maintain the
amount withdrawn for the necessary time period? Consider the use
of this method in difficult financial times. If you have been
temporarily unemployed, the amount of the payment may not be
sufficient to sustain your lifestyle during a prolonged work
stoppage. Individuals applying this strategy have been known to
dip back into the IRA for more money, thus modifying the payment
schedule and subjecting all distributions to the retroactive 10%
This article illustrates just a few of the many issues to
consider before beginning a series of substantially equal
payments from your IRA. These issues and alternative solutions
should be carefully examined with your financial advisor or tax
professional before making any decisions.
About the author:
"Can somebody please help me watch, manage, invest or oversee my
401k" is the question Mr. Morris hears most often that causes
him the most concern. Fearing the American worker is being left
in the dark, Mr. Morris, a fee based Investment Advisor
Representative, based in Central Ohio, with Raymond James
Financial Services, Inc., helps 401k participants get the
most out of their retirement.