Penalty-Free Withdrawals From IRAs Before Age 59 ½ are Possible

Many of you benefit from saving into an employer-sponsored retirement plan such as a 401(k), 403(b) or 457 plan. These plans have their advantages and drawbacks and depending upon the plan, you could get slapped with a 10% tax penalty if you withdraw your funds before age 59 ½.

Because of the potential 10% penalty, many savers fund a Roth IRA, which lets you pull your contributions at any time without tax or penalty. This is because Roth IRA contributions are made after-tax, so if you’re in a pinch, Uncle Sam doesn’t mind if you take those dollars back before turning 59 ½. However, any market gains taken before age 59 ½ may result in a 10% tax penalty (although there are exceptions to this rule also).

But what if you’ve contributed to a Traditional IRA and still find yourself needing some quick cash? Is it possible to get your hands on your money before the age of 59 ½ without a penalty? The answer is yes. There are two little-known exceptions relating to Traditional IRAs that let you pull money before age 59 ½ without either paying taxes, penalties, or both.

EXCEPTION #1: 72t DISTRIBUTION

The first exception, called a 72t distribution, allows for penalty-free tax treatment of IRA withdrawals before age 59 ½. These distributions are also known as a “Series of Substantially Equal Periodic Payments.”

To take advantage of the 72t rule, you have to calculate the amount of annual distributions from your Traditional IRA according to a specific IRS formula. A better idea is to have your financial advisor do the calculation for you (at least you have someone to yell at if the IRS doesn’t like the math). In order to avoid the 10% early distribution penalty, once you trigger 72t distributions, you need to keep withdrawing the appropriate amount out for five years or until you reach age 59 ½ – whichever is later. Changing the withdrawal amount could result in a hefty 10% penalty!

EXCEPTION #2: The 60-DAY RULE

Withdrawals from Traditional IRAs are usually taxable, but a special IRS rule allows you pull money from your IRA without tax or penalty as long as the funds are rolled over to another IRA or placed back into the same account within 60 days of the withdrawal. The 60-day rollover rule also applies to Roth IRAs. You can only use the 60-day rollover rule once every 365 days from the first distribution. So how can you use this rule to your advantage?

Let’s say you’re playing cards with your buddies one night and you notice a newcomer to your group. He seems nice enough and you don’t pay much attention to his crooked nose and thick Chicago accent. Anyway, after a handful of drinks and bad run of cards, you’re out of money, but your newfound friend graciously lends you a handsome sum. Unfortunately, your bad luck continues and you wind up losing your new friend’s money also. It’s at this point he reminds you (in no uncertain terms) that he’d like his money back in one week. When you wake up the next morning, you seem to remember hearing something about missing fingers and broken bones should you not pay your loan back on time.

Luckily, you remember the 60-day rollover rule and thankfully you’ve never had to pull from your account within the last year. The reason is starting January 1st of 2015, this rule applies per taxpayer, not per IRA so an investor can only do one rollover across all of his or her IRAs within any 365-day window. Keep this in mind though; for the 60-day IRA rollover rule, the 365-day window begins on the date of the distribution, not January 1st. The bottom line is you can use this rule to your advantage, and the advantage in this case is being able to keep your fingers and bones intact.

The 60-day rollover rule only applies to rollovers where you actually take possession of the money, so for a trustee-to-trustee transfer of an IRA, since the funds are never received by the investor, no such rule applies. You can make as many trustee-to-trustee transfers per year as you would like.

When using either of the special IRA distribution rules, you have to use the highest degree of caution. For example, being just one day late when rolling over funds from one IRA to another, or not withdrawing the exact required amount while participating in a Series of Substantially Equal Payments could rain down some heavy income taxes and penalties. Even though using these strategies can be very beneficial, it’s best that you consult with an experienced and competent financial advisor and tax accountant before taking action. It’s also a good idea not to borrow money from guys that look like they stepped right off the set from Goodfellas, but to each his own I suppose.

Securities and advisory services offered through Ausdal Financial Partners, Inc.  Member FINRA/SIPC 5187 Utica Ridge Road Davenport, IA 52807    563-326-2064  www.ausdal.com.  Public Retirement Planners, LLC and Ausdal Financial Partners, Inc. are separately owned and operated.