You probably think you can’t take money out of your IRAs or 401k before age 59 1/2 unless you meet a narrow exception to the unpleasant 10 percent penalty on early distributions.
But that’s not true.
We have a variety of planning opportunities here.
Way 1: Roth IRA Contributions
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, and finally
- 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.
Way 2: Traditional IRA Basis
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’s qualified plans, such as your 401(k).
Strategy. Use this taxable amount only rule to reduce your traditional IRA balance to its basis and then liquidate it tax- and penalty-free.
Example. Laura has two traditional IRAs with a balance of $50,000 and basis of $25,000.
- If Laura liquidates the traditional IRAs before age 59 1/2, she will pay taxes and the 10 percent penalty on $25,000; the other $25,000 is tax- and penalty-free.
- If Laura transfers $25,000 from her IRAs to her employer’s 401(k) plan, then the remaining $25,000 is 100 percent basis.
Laura can now liquidate the remaining $25,000 of basis in her traditional IRAs tax-free and penalty-free.
Way 3: Substantially Equal Periodic Payments
And then, on a totally different front, there’s a little-known escape from the 10 percent penalty, called the substantially equal periodic payment exception. It allows you to create a stream of penalty-free traditional IRA distributions starting at any age for any reason.
You have to continue the substantially equal periodic payments for at least five years or until you reach age 59 1/2, whichever is later.
As you can see from the above, you can touch your IRA accounts before age 59 1/2 without a special reason. If you would like my help with some extractions from your IRA accounts, please give me a call at 509-543-7600.