What are the traditional IRA withdrawal rules? What do I need to know before contacting my IRA service provider to let them know that I will be starting my withdrawals? In today’s article, we shall be looking at this matter about traditional IRA withdrawals, in a bid to help you stay away from trouble with the IRS, and so that you do not end up getting penalized. Stick on to the end of this article to find out more about this topic.
Individual Retirement Accounts (IRAs), come with many complex rules. Those who fail to adhere to those rules often end up walking home with significantly less money than they ought to and end up regretting having opened the account in the first place. With traditional IRAs, for instance, there are strict IRA distribution rules, before and after the retirement years. Let’s take a look at some of the very important rules that you should never overlook.
Early withdrawal Rules
Under traditional IRA distribution rules, all withdrawals taken before one hits 59.5 years are usually taxed, and also attract a 10% penalty. While you cannot avoid paying taxes on the withdrawals you make from the IRA, there are some instances in which the 10% early withdrawal penalty is overlooked.
The withdrawals for which you cannot be charged a 10% penalty
All qualified higher education expenses
Traditional IRA distribution rules make a provision for the use of the funds in one’s account to meet their higher education expenses, not only for themselves but also for their immediate family members. This means that one can withdraw funds to pay for their spouse’s, child’s, or grandchild’s higher education expenses, without the fear of being penalized.
Also, there’s no limit to such withdrawals, and one can use the money they withdraw to meet the following expenses:
- School supplies
Room and board provisions are also made for students who will be attending school more than half the time.
Buying a home
The IRS allows you to use up to $10,000 of your traditional IRA funds to make a payment towards the purchase of your first home. You are lucky is you are purchasing the home with your spouse since this rule applies to both of you.
What is considered a “first home” according to the IRS rules? According to the IRS, one is a first-time home buyer if they or their spouse has not been in possession of a principal residence in the last two years. Those who withdraw their traditional IRA funds, for this reason, are however required to use the funds within 120 days, otherwise, they will end up getting penalized.
You are also allowed to use your traditional IRA funds to buy a first home for your immediate relative e.g. child or grandchild.
The birth or adoption of a child
Upon giving birth to a child, one can withdraw up to $5000 of their traditional IRA money. If one is married, their spouse can also withdraw any amount up to $5000 from their traditional IRA as well. This provision was granted on January 1, 2020, as part of the Secure Act. Under this law, people can take early withdrawals and put the money back into their traditional IRA without the funds they pay back being viewed as part of their annual contributions.
Medical expenses and health policy premiums
A traditional IRA account holder is allowed a distribution if they want to pay for medical expenses that are more than 7.5% of their adjusted gross income (note that these medical expenses are unreimbursed). The same amount of money can also go towards meeting their health insurance premium expenses for themselves, their spouses, and children if they are unemployed.
There are several rules that apply in this case, however, including:
- The funds from the traditional IRA can be used to make payments for the portion of the account holder’s medical expenses that are more than 7.5% of their adjusted gross income. If you, for instance, earn $100,000 and you have a total of $20,000 in unreimbursed medical costs, you can use the funds in your traditional IRA to pay for $7500 of the costs.
- For those who opt to use their IRA funds to meet their health insurance premium expenses during unemployment, they are required to cease taking the distributions not more than 60 days after getting a new job.
- Death or permanent disability.
As much as the IRS is quite strict when it comes to early withdrawals, it understands that tough times do not spare even the best prepared of us. This is why they allow you to access your traditional IRA funds if you become disabled. Upon your death, the funds in your account can be allocated to your beneficiaries, or your estate can use them.
Required Minimum Distribution Rules
If allowed to do so, some people can defer their taxes for so long. The IRS prevents this from happening by making it a requirement that upon reaching age 72, one starts taking the required minimum distributions, or RMDs are popularly abbreviated. One must start taking the distributions by April 1 of the year following one turning 72.
One must continue to take their RMDs every year by December 31. This means that one can end up taking two RMDs in their first year, if they wait until the calendar year that comes after turning 72 and fail to meet the April 1 deadline. Those who do not take their RMDs within the required time end up paying a stiff penalty of about 50% of the amount that they fail to withdraw.
Every traditional IRA account holder’s RMDs vary. The IRS arrives at every person’s RMDs by dividing their traditional IRA balance by a specified life expectancy factor. You can opt to withdraw more funds than the RMDs, but you ought to remember that traditional IRA distributions are usually treated as taxable income.
Frequently Asked Questions on “ What are the Traditional IRA Withdrawal Tax Rules?”
1. When can I claim federal estate tax deductions?
Beneficiaries are allowed to claim deductions for the estate tax that are a result of some distributions from traditional IRAs. There is a provision for the beneficiaries to deduct estate tax that is paid on any part of the distribution that is perceived as income in respect of a decedent. He or she is allowed to take deductions for the tax year in which the income is reported.
Note that any taxable part of any distribution that isn’t perceived as income with respect to a decedent is a payment that the beneficiary in question needs to include as income.
2. When can I withdraw or use the assets in my traditional IRA without getting hit with extra taxes?
You are allowed to withdraw or utilize the assets in your traditional IRA at any time you please. You will, however, have to pay a 10% additional tax if you make the withdrawal before you hit 59 ½ years.
If you want to make a tax-free withdrawal of your contributions as a traditional IRA holder, you can do this before the due date for filing the tax returns for the year in which you made them. By doing this, you set yourself free of the 10% additional tax penalty, despite being under 59 ½ years old.
3. What are the tax advantages of a traditional IRA?
A traditional IRA allows you to hold the funds (including the earnings and gains) untaxed until the time to take distributions arrives. According to the IRS website, there are cases in which the distributions aren’t taxed at all if the owner of the account takes their distributions according to the set rules. You can make consultations with your tax consultant about this matter before you start taking your distributions.
4. Can I get tax relief on my distributions as a traditional IRA owner who has faced disasters?
There are special rules that offer tax-favored withdrawals and repayments from specific retirement plans for account holders who have suffered economic losses as a result of various disasters. If you, for instance, lost your wealth during Hurricane Irma, Hurricane Maria, Hurricane Harvey, or the 2017 California Wildfires, you can get tax reliefs on your distributions. You should, as such, make it a point to consult with your IRA service provider and tax consultant about the availability of tax relief options that apply to your account. Doing this will ensure that you take home the maximum amount of retirement payout possible.
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That will be all for this article on what the traditional IRA withdrawal rules are. My hope is that you now know what you ought to avoid, and what you should do, to ensure that your retirement savings are safe. Let me know if you have any questions pertaining to today’s article, or about how to open your self-directed IRA today- drop them in the comments section and I will get back to you ASAP.
I wish you well,
Eric, Investor and Team Member at Gold Retired!