Traditional IRA Withdrawal Education

Ready for your Traditional IRA withdrawal education? (Just an FYI, the word ‘withdrawal’ is sometimes used interchangeably with ‘distribution’ in IRA Lingo.) C’mon, it’ll be easy.

If you’re at or above the magic age (59 1/2)

Once you reach the age of 59 and-a-half, you can withdraw money from your Traditional IRA without penalty, but you’re usually still subject to taxes. It’s taxed as ordinary income at whatever bracket you happen to be in at the time.

So if you’re a millionaire, you’ll likely be screwed, as you’ll probably be in the highest tax-bracket.)

The reason you have to pay taxes on Traditional IRA withdrawals is because technically, you haven’t paid any taxes yet. (i.e. You still owe the IRS. They’ve been waiting patiently this whole time.) Remember, the contributions are tax-deductible (new window) or pre-tax.

IRA Withdrawal Education (Cont.)

If you’re younger than 59 1/2

You have to pay taxes like it’s ordinary income, and you’ll have to pay a 10% penalty on the whole amount.

• So let’s say you are in the 30% tax-bracket and you take a $10,000 early withdrawal (also called ‘premature distribution’)
  • Automatically, you owe 30% of $10,000 or $3,000 for taxes
    • $7,000 remaining
  • Then you also owe an additional 10% of $10,000 or $1,000 for penalty
    • $6,000 remaining
      • You keep $6,000 of a $10,000 distribution
        • That sucks.

See, it pays to get your IRA withdrawal education, no?

Of course, some exceptions

I’m telling you, there are always exceptions : ) You can take distributions early from a Traditional IRA, and not be subject to penalty for the following reasons:

1. Unreimbursed Medical Expense/Health Insurance. If you’re unemployed and are using withdrawals to pay for health insurance, you can avoid the penalty. Or if you have medical expenses that were not covered by your insurance which exceed 7.5% of your AGI (adjusted gross income).
2. First-time Home Purchase. You may withdraw up to $10,000 without penalty for the purchase of your first home.
3. Substantially Equal Periodic Payments. This is kind of a weird rule. You’re able to take penalty-free distributions starting at any age if you take them periodically, in equal payments over your expected life-span.
4. So let’s say you’re 50 and you have $5,000,000 in your IRA (yea, baby!).
   • They expect you to live until you’re 80.
     • That’s 30 years.
     • So they take the balance of your IRA ($5M) and divide it by 30 (years until you probably die).
     • You agree to take a series of 30 equal, yearly payments of $166,666.66 (yea, baby!).
       • You walk away smiling, having avoided the penalty.
5. Higher Education. You can take early, penalty-free withdrawals if you use them for expenses associated with attending a qualified higher education institution (i.e. college or university). You can take this distribution for yourself, your spouse, children, or grandchildren : )
6. Disability. Be careful. You don’t want to qualify for this one.
7. Death. Not this one, either : )

So to complete your Traditional IRA withdrawal education…

If you really want to read the fine print, spend a minute combing through IRS Publication 590 (new window)

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