Early IRA Distributions
DEAR TRUST OFFICER:
I need to get some money from my IRA, but I’m not 59 ½ yet. Is there any way for me to avoid the 10% penalty tax?
You are far from alone in looking to your IRA for emergency funds. According to the IRS, in 2010 an estimated $5.8 billion in penalty taxes were paid on premature withdrawals from retirement plans. That’s on top of the income taxes paid, and because the penalties are not deductible, the income tax effectively applies to the penalty as well. Someone in the 25% tax bracket will be able to keep just $65 of every $100 taken early from an IRA. State income taxes may erode this still further.
That’s why tapping the IRA should be a last resort, it’s tax inefficient. One alternative to consider for those who haven’t reached the magic age of withdrawal is to begin a program of substantially equal periodic payments, geared to life expectancy. In effect, the IRA becomes a quasi-annuity. However, the taxable distributions must continue for five years or until you reach age 59 ½, whichever comes first, whether you need them or not in later years.
See your tax advisors for review of your alternatives before making any decisions that can’t be changed later.
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