How To Go Penalty-Free On Early IRA Distributions

It is often believed that money can’t be taken out of your IRA penalty-free before age 59 ½ unless you meet a narrow exception.

But that’s not true.

There are actually a variety of planning opportunities here to avoid the steep 10% early distribution penalty.

For example, you don’t pay taxes or the 10 percent penalty on amounts you withdraw that you previously contributed or converted to the Roth IRA. These amounts are your “basis” in the Roth IRA. (Remember, you funded your Roth IRA with after-tax money!)

The law says Roth distributions come out in the following order:

  • regular contributions
  • rollover contributions
  • earnings

Example. Jane opened her Roth IRA in 2002. She contributed $30,000 over the life of the Roth IRA. Today, the account is worth $50,000. Jane can withdraw up to $30,000 tax-free and penalty-free regardless of her age.

If you made nondeductible contributions to a traditional IRA, then you have “basis” in all your traditional IRAs. With basis, you have some planning opportunities with your business’ qualified plans, such as your 401(k).

Another opportunity to escape the 10 percent penalty is called the substantially equal periodic payment exception. Under this exception, you are allowed to create a stream of penalty-free traditional IRA distributions starting at any age for any reason.

You will have to continue the substantially equal periodic payments for at least five years or until you reach age 59 1/2, whichever is later.

For more information or help on withdrawing from your IRA account prior to the age of 59 ½, please give us a call at (732) 566-3660.

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