Most people know that if they take money out of an IRA before turning age 591/2, they have to pay a 10% penalty tax on the money. But did you know that there are actually some exceptions to the tax code? If you follow them to the tee, you can pull money out of your retirement account and avoid the 10% penalty tax. Here’s how;
If you have a short-term need for money, you can use the 60 day roll-over rule. If you pull money out of an IRA and redeposit the money within 60 days, the money isn’t considered taxable income and don’t have the 10% penalty tax. You can only do this one time every 12 months, so you need to keep good records to make sure you don’t take more than 1 distribution in any 12 month time period.
If you have money in an employer sponsored retirement plan like a 401k or 403b, you can take your money out after age 55 without incurring a penalty tax. Here’s how;
You have to separate from service with that company after you turn 55, and then take your distribution in order to avoid the 10% penalty tax. If you leave the company before your actual 55th birthday, as long as you turn 55 within that same calendar year, the 10% penalty will not apply, because you’ve turned 55 the year in which you separated service.
But what if you don’t have money in an employer retirement plan and/or you’re not yet 55 and you want to have access to your money and will need it longer than 60 days?
Then you could tax advantage of section 72t distributions. It allows you to set up an IRA account to take what the IRS calls a — series of substantially equal periodic payments — those payments will then avoid the 10% penalty tax.
Payments need to run for at least 5 years or until you turn 59 ½ (whichever time period is longer). Just be warned — the penalty if you don’t follow these rules is severe. If you violate the rule, all the prior years distributions are subject to the 10% penalty tax – in addition to the regular income tax you will have already paid on the distributions.
Sometimes, folks will start a 72t payment plan, and then they come into more money/income and wind up with taxable income that’s higher than what they had originally planned for. Then it becomes a numbers-crunching situation. Do you stop the payments and pay the penalty tax or do you continue the payments? Depending on your circumstances, it may make sense to terminate the 72t payment schedule.
Whenever possible, we encourage folks not to utilize a 72t payment schedule. You have to ensure that you maintain the integrity of the payments to avoid paying the penalty tax down the road, and to a degree you limit some of your flexibility. But under the right set of circumstances, a 72t plan can be a viable planning strategy.
Note: Please keep in mind that this article is for informational purposes only and should not to be relied upon as advice. It is merely a reminder that there are many choices you have available to you, and that planning is the only way to find the right answers for your situation! As with any financial issues, make sure you get the right information before making a decision! If you have any questions, we’ll be glad to help you!