Articles - IRAs

Three Penalty-Free Ways to Withdraw IRA Funds

Many retirement savers believe that they may not withdraw their Individual Retirement Account (IRA) contributions before they reach age 59 1/2 without incurring a 10% tax penalty. Yet, with some restrictions, current tax law allows traditional IRA and Roth IRA owners to withdraw a portion of their IRA money in "substantially equal" amounts each year without being penalized.

Should you need the early use of your IRA funds, the Internal Revenue Service has generally approved three methods for withdrawing funds without penalty. (The amount withdrawn is still subject to ordinary income tax.)

The three withdrawal methods:

1. Life Expectancy Payout is the simplest way to calculate penalty-free IRA withdrawals for a particular year. IRS Publication 590, Individual Retirement Arrangements, provides life expectancy information to factor into the value of funds in your IRA as of December 31. The result will be the penalty-free amount that may be with drawn during the next year. You can obtain a copy of this publication by clicking on the Nichols & Eberth web site, MichiganAttorney.com, and then clicking on the link to IRS forms and documents.
2. Life Expectancy Amortization allows you to:
   1. determine your life expectancy from the IRS tables,
   2. work with your tax advisor to determine the reasonable rate of interest or return your IRA should earn, and
   3. determine how much would have to be withdrawn in equal payments from the IRA balances each year in order to reach zero at the estimated time of death.
3. Annuity Payout is similar to Life Expectancy Amortization, but this method is likely to provide you with a larger annual penalty-free payout from your IRA because it permits you and your tax advisor to choose any reasonable mortality table to determine lifespan. (Such tables may assume a shorter lifespan than IRS tables, resulting in larger annual payments.) Once an expected lifespan has been determined, you and your tax advisor can choose a reasonable interest rate to calculate the annuity factor and then divide that annuity factor into the account balance.

No matter what method of payment you select, your payment schedule must meet the following rules:

• Annual payments must be in substantially equal amounts.
• If the payment schedule is changed or is topped prematurely, all distributions up to that time will become subject to the 10 percent penalty tax. For this reason, you may wish to split your IRAs taking periodic payments from one IRA, while maintaining a separate IRA for long-term investments and emergency withdrawals.

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