Q: You wrote a few weeks back about taking money out of your traditional IRA after you turn 70½. I am only in my mid-40’s but I would like to use some of my IRA money to help pay for my daughter’s college expenses and for expanding my business. Is this possible?
A: There are two aspects to consider in answering your question. The first is fairly simple: when you take money out of your traditional IRA you will trigger income tax based on the amount that you withdraw and your tax rate. In some cases there may be a tax-free portion if contributions were made with after-tax dollars, but these are relatively infrequent. Further, if you do have an after-tax portion, any withdrawals are proportional between the taxable and tax-free portions (i.e., it’s not possible to extract only the tax-free part). So be prepared to pay a significant portion of the money you withdraw to the IRS.
In addition, there is also a 10 percent penalty tax for withdrawals made before you reach 59½. In developing the preferential tax laws governing IRAs, Congress intended retirement accounts be just that: retirement accounts. Consequently, they wrote the 10 percent penalty into the law to discourage taking the money out for other purposes. But in some cases this penalty can be avoided. Here is the list of exceptions to this 10 percent penalty affecting IRA accounts:
• Distributions made to a beneficiary or estate due to the IRA owner’s death. But care should be taken if the heir is the spouse and the spouse rolls the IRA into his or her own IRA. In this case distributions from the surviving spouse’s IRA could still be subject to the penalty.
• Distributions made due to the participant’s total and permanent disability.
• Distributions made as part of a series of “substantially equal periodic payments” based on your life expectancy or the joint life expectancies of you and your designated beneficiary. Distributions must be made annually and must continue for five years or until you are 59½, whichever is later. If you fail to take the required distributions or modify the plan the 10 percent penalty could be assessed for all the distributions taken to date.
• Distributions of up to $10,000 ($20,000 for couples) for qualified first-time homebuyers. In order to qualify as first-time homebuyers, the individual and spouse must not have owned a principal residence for at least two years.
• Distributions to pay for qualified higher education expenses for yourself, your spouse, your child, or your grandchild. Qualifying higher education expenses include tuition, fees, books, supplies, and equipment. Room and board will also qualify, but only if the individual is at least a half-time student. Of course, since taking the distribution results in taxable income the student’s ability to qualify for financial aid may be impacted.
• Distributions to pay for certain medical insurance premiums while unemployed provided the individual has received unemployment compensation for twelve consecutive weeks.
• Distributions to pay for unreimbursed medical expenses that are in excess of 10% of your adjusted gross income. The distribution must be made in the same year the expense is incurred.
• Distributions caused by an IRS levy on the IRA.
• Distributions taken by members of the military reserves who are called to active duty for at least 180 days.
If you do take an early withdrawal, you may need to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, with your federal tax return to report the distribution and any applicable penalty.
The bottom line is that you can take some of the IRA money penalty free for your daughter’s college expenses. But any distribution for use in your business will carry a 10 percent penalty. But I would encourage you to take a look at your finances and see if there is a way for you to avoid using your IRA for anything but your retirement. Taking money out of a qualified retirement plan is not only expensive in terms of taxes, but also in terms of your future retirement plans.
To ensure compliance imposed by IRS Circular 230, any U.S. federal tax advice contained in this article is not intended or written to be used, and cannot be used by any taxpayer, for the purpose of avoiding penalties that may be imposed by governmental tax authorities. The answers in this column are meant to offer general information. You should consult your tax adviser regarding the specifics of your situation. Peter Robbins is a partner in the Boise office of CliftonLarsonAllen LLP, specializing in tax matters for small businesses, individuals, and trusts and estates. Have a question for Robbins? Email your question to firstname.lastname@example.org. Enter “Talking Tax” in the subject line.