When you’re ready to take withdrawals from your IRA, you’ll find there are plenty of rules to follow. Failure to stick to these guidelines could have serious ramifications. The most notable among these is a 10% penalty tax on IRA withdrawals made before age 59.5. Beware, though, as traditional and Roth IRAs have two distinct sets of requirements. As always when making nuanced financial decisions, it can be helpful to consult a financial advisor.
Withdrawal Rules for Traditional IRAs
Traditional IRAs give you a tax break at the time of contribution. And the earnings you make in the account grow tax-deferred. But when you retire, you pay income taxes on the withdrawals you take.
At age 59.5, traditional IRA holders attain full control of their account’s assets. In other words, all withdrawals will be free of any tax penalties, aside from the aforementioned income taxes. Anyone older than 70.5 will additionally need to adhere to required minimum distributions (RMDs), but we go over that below.
What if money is tight and you need to make a withdrawal from your traditional IRA before age 59.5? In this case, you’ll pay a 10% early withdrawal penalty that the IRS levies. Plus, your withdrawals will be taxed as income.
There are, however, some exceptions. You can take early distributions without paying a penalty if those withdrawals are for one or more reasons on the approved list from the IRS. More specifically, this refers to withdrawals for expenses related to medical needs, health insurance, college, a first-time home purchase, disability, military service (longer than 179 days) and more.
Withdrawal Rules for Roth IRAs
You can withdraw the contributions you make to a Roth IRA at any time, without paying taxes or penalties. This is one of the big selling points of a Roth account. However, if you want to tap into the earnings portion of your Roth IRA, you may incur IRS penalties. To be specific, account holders under 59.5 who withdraw from the earnings of their Roth IRA are subject to the 10% early withdrawal penalty.
One major feature of Roth IRAs is the all-important “five-year rule.” This states that you cannot withdraw from your IRA unless five years have gone by since you made your first contribution. To be exact, this process starts on Jan. 1 of the year you deposited your first contribution into your Roth IRA. Only after this half-decade will the money in your account be accessible.
If you’ve met the five-year rule and are 59.5, your Roth IRA distributions are described as “qualified.” On the other hand, any withdrawals made outside of these stipulations are titled “non-qualified.”
IRA Required Minimum Distributions (RMDs)
According to IRS tax law, owners of traditional IRAs must start taking RMDs at age 70.5. How large your RMDs will be depends on your life expectancy, so it’s different for everyone. The initial RMD deadline is April 1 of the year following the year during which you turn 70.5. After this, your continuing annual RMD deadline will slide back to Dec. 31.
Roth IRAs are subject to an entirely different set of rules. In fact, Roth account holders don’t have any RMDs whatsoever. Every bit of your balance is tax-free, so you can complete withdrawals whenever you see fit. Things change when you pass away, though, as heirs of Roth IRAs will have their own life expectancy-based RMDs.
IRA Rollover Rules
Want to perform a rollover from a 401(k) to an IRA or from a traditional IRA to a Roth IRA? Because 401(k)s and traditional IRAs are both funded with pre-tax dollars, it’s easy to do a rollover from a 401(k) to a traditional IRA. IRA rollover rules give you 60 days to make the rollover. If you keep your money for more than 60 days without performing the rollover the money will be treated as a withdrawal and taxed and penalized accordingly. To make things easy on yourself and avoid the chance of missing the 60-day deadline, ask the brokerage that houses your IRA to help you enact a direct rollover.
What about a rollover to a Roth IRA? You may decide to rollover your existing retirement account to a Roth IRA because you want to work with a different, lower-fee brokerage, or because you want to take advantage of the tax benefits of a Roth IRA. You can roll over traditional IRAs, 401(k) plans, Roth 401(k)s, 457(b)s and more into Roth IRAs. The only potential problem is with a SIMPLE IRA, which you can only rolled over to a Roth IRA after two years. If you rollover a pre-tax account like a traditional IRA to a Roth IRA you’ll need to pay conversion income taxes on the contributions, earnings and interest your traditional IRA accumulated.
Some people choose what’s known as a backdoor Roth conversion to get around income caps for contributing to a Roth IRA. With a backdoor Roth, high earners can contribute to a nondeductible traditional IRA and then do a rollover to a Roth IRA, penalty free.
Retirement “Plan A” is to set up a low-fee retirement account, automate your contributions and then wait to take distributions from the account until you’re in retirement. If you need to turn to “Plan B” and take an early withdrawal, be aware of the consequences of doing so. Having a fully-stocked emergency fund can save you from having to tap into the retirement savings you’ve worked hard to accrue.
Tips for Getting Retirement Ready
- Figure out how much you’ll need to save in order to retire comfortably. An easy way to get ahead on saving for retirement is by taking advantage of employer 401(k) matching. To reveal what you can likely expect in Social Security payments, stop by SmartAsset’s Social Security calculator.
- Work with a financial advisor. A matching tool like SmartAsset’s can help you find a person to work with to meet your needs. First you’ll answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to up to three who suit your needs. You can then read their profiles to learn more about them. You can even interview them on the phone or in-person and choose whom to work with. This allows you to find a good fit while the program does much of the hard work for you.
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