Withdrawing money from an IRA: Key retirement savings tips

You have resisted the urge to spend all your money and faithfully saved up for retirement. Now, you want to know when you can reap the rewards. Before you start pulling from your accounts and kicking back, you need to understand these rules about withdrawing money from an IRA.

What Should I Know About Withdrawing Money From an IRA?

IRAs, or individual retirement arrangements, are popular because they are self-guided and tax-deferred. They let you choose how to contribute and invest, so they are ideal for building unique nest eggs. This liberty has its limits when it comes to withdrawals, or distributions, however:

• Only specific withdrawals count as qualified and free of tax penalties.
• Certain withdrawals, known as required minimum distributions or RMDs, become mandatory for traditional individual retirement arrangements once you reach a certain age.
• Roth IRAs include tax penalties, but they offer more exemptions, many of which are covered in Rule 72(t) of the tax code.

The Modern IRA Landscape

Economic experts say that even though the economy has sometimes been slowing since the turn of the century, there are still ample opportunities to invest. Unfortunately, many people are still behind, with around one-third not having saved anything for their retirement years and the majority having saved under $10,000. Opening an IRA may be a good way to buck the trend since they lack minimum contributions. IRAs allow you to invest at your own pace and do not restrict the number of accounts you open.

How Can I Withdraw Money From an IRA?

Penalties and restrictions aside, the act of withdrawing money from an IRA is not too complicated. Investors whose IRAs are managed by brokers typically do it by scheduling a simple transfer online. They usually have the option to withhold taxes so that they do not end up owing extra when they go to file for that year.

IRA Fundamentals

The way you save and withdraw from your IRA will vary based on your choice of platform, investment strategy and account type.

Traditional Individual Retirement Arrangements

These accounts involve tax-deductible, tax-deferred contributions. You can claim your yearly contributions on your returns, and you pay when you eventually withdraw money from an IRA or receive the earnings it produces.

Roth IRA

Your Roth IRA contributions use your post-tax money, so you do not have to pay when you withdraw or receive earnings. The one stipulation is that the IRA must have been collecting contributions for at least five years before you pull money out.

The Many Classifications of Withdrawing Money From an IRA

Not all retirement account disbursements are the same, yet there is a great deal of overlap between traditional and Roth IRA withdrawal rules. These accounts intentionally accommodate those who have reached retirement age, or 59½, and they can heavily penalize those who do not use them as laws like Section 72(t) intend.

Early Withdrawals Explained

Early withdrawals occur before you are 59½ years old. If your account is a Roth IRA, you will likely pay extra taxes equivalent to 10 percent of the withdrawal amount and taxes on your earnings. With a traditional account, you will simply owe the 10 percent.

Required Minimum Distribution

Required minimum distributions become mandatory for traditional individual retirement arrangements once you reach 70½. They are calculated using a formula that accounts for your age and other factors. If you have a Roth IRA, you won’t have to worry about these distributions, but someone who inherits it after you die might.

The other important thing to remember about required minimum distributions is that they are not optional. If you fail to withdraw money from an IRA after reaching the specified age, then you will pay the penalty.

Hardship Withdrawals

Uncle Sam is not completely heartless, at least when it comes to the tax code. If you need to dip into your account after a genuine qualified hardship, such as a disaster that damages your home, you can take a limited-amount distribution that you do not have to pay back.

Substantially Equal Periodic Payments

You may be able to avoid the 10 percent penalty by withdrawing money from an IRA in at least five Substantially Equal Periodic Payments, or SEPPs. These distributions are commonly used by people who want to retire early. As per rule 72(t), you calculate the amount of the payments using an IRS-vetted methodology based on:

• Amortization that accounts for your single or joint life expectancy to produce fixed annual payments.
• Annuitization that determines fixed annual payment sums based on an annuity factor.
• Minimum distributions that may vary and are typically lower than the other options.

Death or Total and Permanent Disability

These disbursements are for those who are incapable of partaking in a “substantial” form of gainful activity. Physical and mental disability cases are both eligible. Before withdrawing money from an IRA, however, it is important to remember that:

• The IRS will not automatically qualify you for a 72(t) tax exemption just because a disability has left you unemployed.
• The definition of substantial gainful activity usually encompasses any part- or full-time work for which you earn minimum wage.
• You need a doctor to confirm that your condition is indefinite, prolonged or terminal.

Qualified Higher Education Expenses

A qualified higher education expense is a payment for books, supplies, tuition or fees. You can avoid the early penalty if you withdraw money from an IRA to fund one of these costs. You also do not have to be the student yourself. For instance, you might be supporting your spouse’s or grandchild’s higher education.

Some caveats to this rule have been borne out in audits and tax court disputes. For instance, the IRS maintains that you might still pay the penalty if the expense and the withdrawal did not happen in the same year.

Penalties and Taxes

Feeling wary about withdrawing money from an IRA? While you should never be afraid to put your retirement funds to use as needed, what comes next might make you even more interested in finding a brokerage that helps you avoid investment mistakes.

Traditional IRA Penalties and Tax Implications

It is important to know that the penalties for early withdrawals are not the whole story. For instance, in addition to the 10 percent, you will also have to pay any income tax you would usually owe.

Roth IRA Penalties and the Tax Implications of Withdrawing Money From an IRA

Although Roth IRAs run less risk of loss because you have already paid your tax, you still have to meet the five-year rule. Do not get confused into thinking you are in the clear because you opened an account five years ago, however. The countdown starts on the first day of the year in which you first contributed.

Other Common Exceptions

If you spend a while looking around the tax code — which is a lot easier to do when you save time with a better investment platform — you will run into some other ways to avoid the penalty:

Home Purchase

Want a new house? You are allowed to take $10,000 from a traditional IRA to do so, but only if it is your first home. Oddly enough, the IRS says that first-time homebuyers include people who have not owned a principal residence in the past two years, so if you like periodic apartment living, you may luck out.

Medical Expenses and Health Insurance Premiums

Although you can pay certain healthcare expenses by withdrawing money from an IRA, you are only allowed to:

• Pay for costs that you will not be reimbursed for.
• Make a maximum payment of 7.5 percent of your AGI, or adjusted gross income.
• Pay for insurance premium costs you incurred while you were unemployed if you withdraw from an IRA within 60 days of taking a new job.

Rule 72(t) Exceptions

Thinking about using SEPPs to avoid the penalties associated with withdrawing money from an IRA? There are significant limitations. For instance, rule 72(t) payments are not eligible for conversions or rollovers to other retirement accounts. You also cannot use a 72(t) calculator to come up with payment amounts and then switch to a different rule 72(t) method halfway through. If you do, you will end up paying the 10 percent not only on the remaining 72(t) disbursements, but also be retroactively charged for the earlier ones!

Rule 72(t) makes for fairly hefty reading material. For example, it accounts for a range of situations that may overlap, such as how taxes are assessed for someone withdrawing money from an IRA as a military reservist who gets called up to active duty and public safety employees who receive distributions from government plans.

As with most regulations in the U.S. Code, rule 72(t) also references a variety of other statutes. In short, it is worth finding a comprehensive investment tool that makes it easy to take stock of your portfolio so that you can confirm you are following the regulations before you withdraw from an IRA.

Traditional vs. Roth IRA and Other Withdrawals

There is no need to be confused about withdrawing money from an IRA. Even though the distinctions are not always immediately apparent, the key things to remember are that:

• Roth IRAs provide a greater range of exceptions for early withdrawal penalties.
• Only traditional individual retirement arrangements incur RMDs during the original holder’s lifetime.
• Inherited IRA penalties may take the form of excise taxes on withdrawals that do not meet the minimum distribution requirements.
• Simple IRAs allow employer contributions and charge early withdrawal penalties on a graduated scale.

Put Your IRA Tax Exemptions to Work

Tired of struggling to make sense of rule 72(t) or withdraw money from an IRA painlessly? Why run the risk of incurring 72(t) penalties or making other missteps? The ease of managing your portfolio with M1 means that you always know precisely where you stand. We have made it simple to discover better returns that suit your goals, and what is more, you do not have to pay a commission to exercise your right to invest confidently.

Whether you are retiring next week or still nurturing your nest egg, you need an investment partner you can depend on.