IRA - early distribution - no penalty

[Susie Q]

Client is single, 57 years old. She has negative taxable income most years but is required to file. She has an IRA in the amount of around $400,000. I realize that she would be penalized if she takes IRA distributions before 59 1/2.

Thought that she could take some before that magic age using a special formula. Have been looking in the Taxbook and can't find the reference to those withdrawals prior to 59 1/2 for a 5 year period. She will be receiving Social Security (about 18,000 per year) when she is 60 from deceased spouse. Just wanted to see if she could get some of this IRA with no tax or at the 10% level. I know that when she starts receiving her SS, the tax bill will go up.

[Bees Knees]

TTB, page 13-3, the 4th one - Section 72(t)(2)(A)(iv).

Unless you are an actuary, you will need professional help to determine the amount needed to satisfy those requirements.

[Roland Slugg]

Good tax planning

In your client's case it may be a smart thing to do. She can attempt the annuitization (i.e. life expectancy) method and avoid tax and penalty, but the distributions might not be needed (or tax smart) after she turns 60 in 3 years. It might be best for her to just plan to pay the 10% penalty. That's still a pretty cheap tax rate. Too bad she didn't take some out in previous years.

Don't forget the medical exception, allowing her to take out an amount, penalty-free, equal to her deductible medical expenses, even if she doesn't itemize.

If you're able to do fairly precise tax planning for this client, you might even consider recommending an IRA distribution that will yield net taxable income up to the top of the 10% tax bracket ... $7,550 for 2006. Remember to back out net LTCGs and qualified dividends, as they are a separate total and have their own low, 5% tax rate.

[Unregistered]

Thank you for the suggestions. The client has a lot of medical expense every year (around 12,000.) She has high insurance premiums and at least $4,000 in co pays. She had a kidney transplant and her premiums jump about $1,200 every year.

[Bill Tubbs]

Convert to Roth?

If she doesn't need the money right now -- just wants to reduce tax later on -- another thought _MAY_ be to convert some from Trad IRA to Roth IRA. These amounts would not be subject to 10% penalty; and since client has negative taxable income, a conversion equal to that negative amount could end up being tax free. Then in a couple years when she hits 59 1/2, she can withdraw as much as needed without affecting her taxable income.

Of course, this could be combined with withdrawing for medical reasons to give desired effect. The medical exclusion would allow her to pull some out of the IRA and use; the conversion would just move it into Roth but would still tie it up for a while to avoid the 10% penalty.

Lots of room for calculations here, depending on the desired end result. Enjoy!

Bill

[Roberts]

percentages

To make a penalty free distribution, it isn't difficult to figure out her percentage to withdraw. Just inform the financial advisor that this should be done or ask for help via a mutual fund company or someone at the managing firm. It's a very easy process.

Lot of people automatically assume that you should defer withdrawing funds from IRAs for as long as possible but the reality is this isn't always a good idea for everyone.

[sea-tax]

To make a penalty free distribution, it isn't difficult to figure out her percentage to withdraw. Just inform the financial advisor that this should be done or ask for help via a mutual fund company or someone at the managing firm. It's a very easy process.

Lot of people automatically assume that you should defer withdrawing funds from IRAs for as long as possible but the reality is this isn't always a good idea for everyone.

Good point Roberts , I have been telling people that for years but some people are hard to change. This is exactly why my finanical planning clients get more benefit from me than Joe broker down the street. I understand both sides of the coin.