Tax Tips & Calculators

Retirement plans, like IRAs and 401(k) plans, allow you to save for your future. However, if you don't follow the plan rules, you might receive tax penalties for:

• Contributing too much money in a year
• Withdrawing your money too soon
• Failing to withdraw your funds by the required minimum distribution date

You also might receive an exception to these penalties.

Exceptions to Early-Distribution Penalties

Since you usually put money into a tax-deferred savings plan to save for your future retirement, the law provides for a 10% early-withdrawal penalty. You're usually subject to the penalty if you withdraw money from your retirement plan before age 59 ½. However, exceptions to the 10% early-withdrawal penalty exist.

The penalty doesn't usually apply to distributions from your employer plan or IRA if:

• You're totally and permanently disabled.
• Your beneficiary receives the distribution from your retirement plan after your death.
• You receive distributions as a series of substantially equal periodic payments based upon your life expectancy – or the joint life expectancies of you and your beneficiary.
• You receive the distribution after separation from employment during or after the year you reach age 55 – 50 for qualified safety employees. However, this exception doesn't apply to IRAs.
• You use the distribution to pay medical expenses that are more than 7.5% of your adjusted gross income (AGI).
• You received the distribution as a reservist or National Guard member if on active duty for at least 180 days.
• A federal tax levy forces your qualified plan or IRA to make a distribution.
• An alternate payee received the distribution under a qualified domestic relations order (QDRO). This exception doesn't apply to IRAs.

IRAs have additional exceptions to the 10% early-withdrawal penalty. The penalty for a distribution from your IRA doesn't apply if:

• You use your IRA distribution to pay for health insurance premiums if both of these apply:
  
  • You're unemployed.
  • You've received unemployment compensation for at least 12 consecutive weeks.
• You use your IRA distributions to pay for higher-education expenses.
• You use your IRA distributions of up to a $10,000 lifetime limit to purchase, build, or rebuild a home for these people if they haven't had an ownership interest in a main home for at least 2 years:
  
  • Yourself
  • Spouse
  • Child
  • Grandchild
  • Ancestor

Even if you don't pay a penalty, the taxable portion of the distribution will be taxed as ordinary income.

Rolling Over Your Employer-Sponsored Retirement-Plan Account

If you roll over your company retirement-plan assets into an IRA, you might be able to take distributions and avoid the 10% early-withdrawal penalty. However, the reverse can also be true.

Ex: If you separate from service after reaching age 55, you can usually take penalty-free distributions from the qualified plan. However, if you were to roll over the employer-plan assets into your IRA, you couldn't use this exception since it isn't available for IRA distributions.

Before rolling over your employer-sponsored retirement plan to an IRA, consider:

• When you'll need the funds
• The penalty exception(s) for the account you want to roll the funds into

If you roll over your plan assets, you'll want to transfer the assets in a direct rollover.

With a direct rollover, the plan administrator will send the rollover distribution directly to the recipient IRA or employer plan.

If you take a distribution and roll it over yourself, the money you'll receive will be the distribution amount minus the amount paid to the government under mandatory federal income tax withholding. So, you'll need to find money to equal the withholding to fund the rollover within the required 60 days. If you don't fully fund the rollover within 60 days, you'll pay a penalty on the deficiency.

Special Cases

Rolling over your retirement plan distribution into an IRA prevents you from using the special 10-year averaging rules if you:

• Were born before Jan. 2, 1936
• Are a beneficiary of a plan participant born before Jan. 2, 1936

If you don't want tax withheld from a retirement plan distribution that isn't a rollover, you must complete Form W-4P. If you don't withhold tax, you might have to make estimated payments for your tax liability. Tax isn't usually withheld if it's reasonable to expect the distribution won't be included in gross income.

Rollover – 60 Days From When?

When you roll over a distribution from your qualified retirement plan to an IRA, you have 60 days to complete the rollover. The 60 days begins on the day you receive the check.

Exception Due to Death

If the IRA owner dies while there's still money in the account, exceptions vary.

Death and the Traditional IRA

Beneficiaries, regardless of the IRA owner's or beneficiary's age, don't have to worry about the 10% early-withdrawal penalty. However, the beneficiary will pay tax on distributions if the IRA owner would have paid tax on those distributions – even though the funds are inherited.

If you inherit the IRA from your spouse, you have the option to treat the IRA as your own and defer the minimum required distribution until you reach age 70 ½. If you're not a spouse, you might still qualify to use the IRS life-expectancy tables to determine your required distributions over your life expectancy.

Ex: Arnie's father died in 2008, and he's the designated beneficiary of his father's traditional IRA. Arnie was 53 years old in 2009. According to the IRS tables, his life expectancy in 2010 is 31.4. If the IRA was worth $100,000 at the end of 2007, his required minimum distribution for 2010 is $3,185 ($100,000 / 31.4).

If the value of the IRA at the end of 2010 is again $100,000, Arnie's required minimum distribution for 2011 would be $3,289 ($100,000 / 30.4). Instead of taking annual distributions, Arnie can take distributions of the entire account anytime, as long as the account is completely distributed within 5 years of his father's death (the 5-year rule).

An entire IRA distribution might be subject to the 5-year rule if:

• The IRA owner hadn't designated a beneficiary.
• The deceased's executors don't designate a beneficiary by September 30 of the year following the year of the IRA owner's death.

Death and the Roth IRA

If you inherit a Roth IRA, the money is usually tax-free if it's a qualified distribution. To be a qualified distribution, the funds must have remained in the Roth account for 5 years before they're withdrawn. The 5-year holding period will:

• Include the amount of time the funds were in the account during the deceased's lifetime
• Will not start over when the beneficiary inherits the funds

If you inherit the Roth from your spouse, you can treat it as your own. So, there are no required withdrawals during your lifetime. However, if you're not the deceased's spouse, you must, depending upon the situation, do 1 of these things:

• Take required minimum distributions from the account
• Use the 5-year rule

Getting Your Money Early

There's a way to receive distributions from your traditional IRA without paying the 10% early-withdrawal penalty – even if you receive the distributions before age 59 ½.

To receive the distributions without a penalty, all of these must apply:

• The distributions must be part of a series of substantially equal payments based upon:
  
  • Your life expectancy
  • The joint life expectancies of you and your beneficiary
• You must use an IRS-approved distribution method.
• You must take at least 1 distribution annually.
• You must receive the distributions for at least 5 years and until you're at least 59 ½.

If you haven't yet received payments for at least 5 years, you might have to pay the 10% early-withdrawal penalty even if you modify your method of distribution after reaching age 59 ½. In that case, the tax applies only to payments distributed before you reach 59 ½. Although this installment method saves you the 10% early-withdrawal penalty, you'll still have to pay tax on amounts not considered a return of your nondeductible contributions.

Minimum Required IRA Distribution

You must begin withdrawing money from your traditional IRA by April 1 of the year following the year you reach age 70 ½. The IRS will assess a 50% penalty if you don't withdraw the minimum required amount.

If your 70th birthday occurs between January and June, you'll turn age 70 ½ before the end of that year. You must begin taking your required minimum distribution from your IRA by April 1 of the following year. However, you might want to take your first distribution in the year you turned age 70 ½ to avoid having to take 2 distributions in the next calendar year.

If your 70th birthday is after June 30, your first required minimum distribution would be the next year. You could wait until April 1 of the following year to take it.

Minimum withdrawals are based on life expectancy. After determining your minimum required distribution, you can take the full amount from just 1 account or from several accounts.

Ex: You're required to withdraw $10,000 this year, and you have 2 accounts. You can withdraw the entire amount from just 1 account, or you can split the distribution between the 2 accounts. If you fail to withdraw the minimum required amount, you'll be subject to a 50% penalty. However, the IRS might waive the penalty if you have reasonable cause for the failure, like poor health.