When Congress invented the IRA as we know it – way back in 1974, with the Employee Retirement Income Security Act, or ERISA – they wanted to ensure that people really used their IRAs or Self-Directed IRAs for the purpose of retirement security.
They didn’t want people to use the accounts to time their income tax liability, or to park savings somewhere for the short or medium term. So they imposed a minimum age you could take money out of your IRA – 59½. Try to take money out before then, and you’ll have to pay ordinary income taxes on the full amount withdrawn – plus and additional 10 percent excise tax.
Congress also didn’t want you to be able to defer income taxes indefinitely. Sooner or later, Uncle Sam wants his cut. And so Congress enacted provisions that force traditional IRA, SEP IRA, SIMPLE IRA and 401(k) plans. You must begin taking distributions by not later than April 1st of the year after you turn 59½ or you will liable for capital gains taxes on the amount.
However, Congress also realized that there had to be some way for people to withdraw some of that saving in the event of an emergency, or simply early retirement, or people would be afraid to contribute money to them, essentially locking their money up until retirement age.
And so Congress enacted a series of exceptions to the early withdrawal penalty for those not yet age 59½. If it’s a Traditional IRA and you deducted your contribution, you’ll still have to pay income taxes on the whole distribution. If you made nondeductible contributions to a Traditional IRA, you’ll have to pay income taxes on the gains.
Here they are:
Purchase of a first home. You can withdraw up to $10,000 to use as a down payment on a first home, penalty free. It doesn’t have to be your own home – you can use it for a down payment for your child, your spouse’s child, your spouse or even a parent. And the first-time homebuyer definition isn’t all that strict: You’re a first time homebuyer, or the recipient of the down payment money is a first time homebuyer as long as the homebuyer has not owned a home in the last two years.
Contract didn’t go through? Change your mind? Put the money back in the Self-Directed IRA within 120 days and there’s still no penalty.
Medical bills. Did you have medical bills exceeding 10 percent of your income? You can tap your Self-Directed IRA to help you with the cost. The catch is you have to make the distribution in the same year you incurred the medical expense. So it’s tricky at the very end of the year! For more flexibility, consider a health savings account/high deductible health plan if you qualify. With these, all withdrawals to pay qualified medical bills are tax-free, and not just bills in excess of 10 percent of your AGI.
Health Insurance. Did the ACA make your bills go up? You aren’t alone. You can tap your IRA to pay health insurance premiums, including COBRA premiums, if you’ve been unemployed for at least 12 consecutive weeks – and receiving unemployment benefits.
Disabled? If your disability is significant enough that you can no longer engage in employment, you may be able to qualify for penalty-free distributions. You’ll have t pay income tax, but at your current rate, not at the marginal rate you were subject to when you contributed the money. This isn’t for a case of the sniffles:
You’ll need a doctor’s note that your disability is going to be ‘one of long, continued and indefinite duration.’
College/Education Expenses. Higher education expenses qualify for a penalty free withdrawal from IRAs, but not expenses for primary and secondary school. You can make the withdrawal to pay for your own education or that of your spouse, children or grandchildren. Qualified expenses include books, tuition, fees, required supplies, and for students attending at least half-time, room and board expenses. Be careful, though: If you’re relying on need-based financial aid, your traditional IRA distribution counts against you for the purposes of calculating need-based financial aid under the federal system.
Early Retirement. You can actually retire any time you want – provided you commit to taking systematic, “substantially equal” periodic withdrawals from your IRA. Essentially, when you do this, you are turning your IRA into an annuity. You have to use a method of calculation approved by the IRS, and take at least one payment each year, in accordance with Section 72(t) of the Internal Revenue Code.
Military Duty. Are you a reservist or National Guard member called to active duty with the U.S. Armed Forces for a period of at least 179 days? You can take a penalty-free IRA withdrawal if you need to.
If you’re taking distributions from a Roth, rather than a traditional IRA, any money you withdraw is tax-free, as long as the money has remained in the account for at least five years.
Self-Directed IRA Rules The distribution rules for self-directed IRAs and self-directed Roth IRAs are exactly the same as their conventional counterparts. However, take care that in the process of trying to liquidate part of your self-directed IRA, you don’t accidentally trigger a prohibited transaction. Your IRA cannot sell assets to or buy them from you, your spouse, descendants or ascendants or their spouses, nor entities they control. If you do, the entire IRA could be disallowed, generating unwanted taxes and penalties.
Need help with IRA Rules? The team at American IRA, LLC is an expert source for all rules and regulations regarding IRAs, Roth IRAs, SEP IRAs, SIMPLE IRAs and even 401(k)s. With special expertise in self-directed retirement investing strategies, American IRA, LLC is eager to assist you. Call us at 866-7500-IRA(472) or visit us online at www.americanira.com.