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May, 2009:

Making an Income For Yourself, Part 1

May 14th, 2009
by jblankenship.
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One of the really critical aspects of financial planning that often is overlooked in the early stages is planning your income during retirement.  It’s really not just a matter of withdrawing money as you see the need – there’s a benefit to planning it out and having a strategy as you create your income stream.

First of all, as with any planning activity, you need to determine a couple things:  where you are now, and what your goal is.  The first part, where you are now, is simple if you’ve got a handle on your overall portfolio… if not, you may need to spend some time organizing things.

mountain-stream-by-jasonb42882

Where You Are Now…

Split your portfolio into two categories:  income and assets.  So, if you have a pension plan at work that will be providing you with $x of income, count that in your income stream, along with annuities, rental and/or royalty income, and the like.  Include any part-time income that you intend to receive as well.  Total up all of these income items.

In another list, tally up all of your assets:  IRAs, 401(k) plans, the value of your vacation home, rental property, cash value of life insurance, savings accounts, and any other accounts or assets you might have.  Total these up as well.

Lastly, add up all of your liabilities – any loans, debts, or mortgages.  Break this list into two parts:  consumer or short term debt, and mortgages.  Tally up the two lists.

We won’t go into a lot of detail on the debt issue for now, but suffice it to say that if the short term debt category is significant (you define it – what percentage of your annual income is required to service the debt?), you’ll really should spend some time whittling that down before going into full retirement.

Where You Are Going…

The next piece is to quantify your goals – quantified to understand the income stream that is required to support your retirement lifestyle.  Tally up the cost of housing, taxes, insurance; hobbies, travel, and gifts for grandchildren; healthcare, transportation, and home improvement… you get the picture.  The idea is to be as complete and realistic about your income requirements as possible.

This is a good time to sit down with your spouse and talk about what really matters to each of you: those life goals that you’d like to accomplish, and how important each item is in the overall scheme of things.  Perhaps you already know these things about one another, but then again, you may not.  Take the time to listen to each other and learn.

With your list of lifestyle costs, you should be able to easily break this down into “required/fixed costs” and “variable cost/optional” categories.  An example of a required expense for most folks would be the electric bill.  This is also generally considered a fixed cost as well (even though it may vary over time, it’s difficult to reduce the figure appreciably if necessary).  A variable/optional cost might be fuel for your vehicle.  If you have public transportation available, you could impact that expense considerably.  Tally up the “required” category and prioritize the “optional” items in a separate list. Add the two lists together for a starting point for your monthly expenses.

The Bottom Line

Now that we know what our monthly expenses are and have tallied up our income streams, it’s time to bring the two together.  Look at the table below for an example:

Expenses    
Mortgage $ 1,000.00  
Insurance 75.00  
Taxes 200.00  
Auto 200.00  
Fuel 100.00  
Food 800.00  
Travel 500.00  
Charitable Contributions 100.00  
Total Expenses   $ 2,975.00
     
Income    
Pension 600.00  
Social Security 400.00  
Annuity 500.00  
Rental Income (less expenses) 500.00  
Total Income   $ 2,000.00
     
Difference   $  (975.00)

As you can see, our income estimate comes short of the requirement in expenses.  At this stage two things can be done:  Either expenses can be reduced, or you can increase your income (if you have a way of doing so) – and most likely it will be a combination of the two.

The first method, reducing expenses, is why we prioritized the variable or optional expenses.  Take a look at your list, and see if there are any items that you truly don’t need or are not high enough on your priority list.  Put those items on the back burner for now, and re-total your table.  Chances are, you haven’t been able to trim things enough to get your income to match up with your expenses.

In Part 2, we’ll get into how to create an increase on the income side of your sheet, in order to balance things out.

Photo by jasonb42882

A SIMPLE Kind of Plan

May 12th, 2009
by jblankenship.
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The SIMPLE Plan is a type of retirement account for small businesses that is simpler (ah hah!) to administer and more portable than the 401(k) plans that are more appopriate for larger businesses.  SIMPLE is an acronym (probably a backronym, more likely) which stands for Savings Incentive Match PLan for Employees.

200px-lynyrdskynyrdA SIMPLE Plan can be either a part of a 401(k) plan, or using IRAs – and what we’ll cover is primarily the IRA-type of SIMPLE plan.  The difference is that there are more restrictions on employer activities, and less room for error (as can be the case with 401(k) plans).

A SIMPLE Kind of Plan

Much like a 401(k) plan, a SIMPLE Plan is an agreement between the employer and employee wherein the employee agrees to a salary deferral.  This deferral effectively reduces the employee’s salary (take home pay), and the employer then agrees to contribute the deferred amount into the SIMPLE IRA account on behalf of the employee.  These contributions must be made to a SIMPLE IRA account, not a Traditional IRA.

To be eligible for a SIMPLE Plan, the employee must have received at least $5,000 in compensation during any two years prior to the current tax year, and can reasonably expect to receive at least $5,000 in compensation in the current tax year (calendar year).  For the purposes of the SIMPLE Plan, a self-employed individual would be considered an employee if she received earned income as described.  Also, certain classes of employees can be excluded from participation, such as union members subject to collective bargaining, or nonresident aliens who have received no compensation from US sources.

Types of Contributions

There are three different types of contributions that can be made to a SIMPLE Plan – salary deferrals, employer matches, and nonelective contributions.

Salary Deferrals are much the same as 401(k) salary deferrals.  The employee decides to defer a percentage of his salary, which reduces his taxable and take-home pay, and the deferral is contributed to a SIMPLE IRA on his behalf.

Employer Matches are also similar to the same activity in a 401(k) plan.  The employer elects to match the employee contributions, dollar-for-dollar, up to 3% of the employee’s salary, although this amount can be less.  (see Limits below for additional information)

Nonelective Contributions - in some cases, the employer may decide to make contributions on behalf of ALL eligible employees, rather than only for those that are participating in the SIMPLE Plan.  In this case, the employer has opted for making the Nonelective Contributions instead of Employer Matching Contributions.  These Nonelective Contributions are for 2% of employee salary.

Limits

For Employer Matching contributions, the employer has some leeway in making the contributions for a particular tax year, but there are quite a few restrictions on how this leeway can be applied:

  • as described above, in general the matching contribution must be dollar-for-dollar up to 3% of the employee’s deferral for the year; however -
  • the matching contribution can be reduced to as little as 1% (or any amount between 1% and 3%) for a tax year as long as the amount is not reduced below 3% for more than two out of five tax years (including the current tax year) and the employees are informed in a timely fashion of the reduction in match.
  • the Nonelective Contribution of 2% can be substituted for the Employer Matching Contribution for any given year as long as employees are notified.

Contributions (for 2009) are limited to $10,500 in employee deferrals, plus a catch up provision of $2,500 if the employee is age 50 or older during the tax year.  Employer matches are limited to the amount the employee defers, up to 3%.  

Note that SIMPLE deferral is counted toward the overall 401(k) limit ($16,500 for 2009) in deferrals for the tax year.  If an employee is subject to more than one retirement plan, this limit applies to all deferrals for the tax year.

Gallimaufry*

There are a few additional things of interest regarding rollovers and the SIMPLE plan that must be pointed out:

 

  • You are not allowed to rollover or transfer funds from a Traditional IRA into a SIMPLE IRA.  If this is done by mistake, you can recharacterize those funds back into a Trad IRA (see this article for more information on recharacterizations)
  • In order to rollover amounts from your SIMPLE IRA into a Traditional IRA, the account must have been in existence for at least two years; otherwise your only option for a rollover is into another SIMPLE IRA (which then inherits the earlier SIMPLE IRAs starting date for rollover purposes).
  • The same two-year rule applies to Converting a SIMPLE IRA to a Roth IRA.
  • Early distributions (not subject to any of the exceptions) that occur during the first two years of the account’s existence are subject to a 25% additional penalty (instead of the usual 10% penalty for other IRA accounts).

 

Other than those restrictions, all of the other distribution rules apply to SIMPLE IRAs that apply to Traditional IRAs:  distributions are taxable as ordinary income; with some exceptions, qualified distributions can not begin until age 59½; rollovers and trustee-to-trustee transfers are allowed as non-taxable events (subject to the two year rule above); conversions to Roth IRAs are allowed without penalty (subject to the two-year rule); and early distributions not subject to exception are subject to an additional 10% penalty (25% in the first two years as described above).

(* a hodgepodge of additional stuff)

Contest for today:  The first person to leave a comment that explains why I used the particular picture above for this article will receive a pound of our delicious virtual back-bacon.  Extra points if you can mention something unique about that particular picture, as well.  Best of luck to all participants! (Canadians are welcome to guess this time as well!) :-)

Photo by Thomas Hill

Five Examples Of When NOT to Listen to Mom

May 10th, 2009
by jblankenship.
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This post was one of the earliest posts on this blog - back in 2004.  But I thought that it was still applicable today as it was then, and so I figured I’d republish it today, being Mother’s Day and all.

finger-sandwiches-for-the-birthday-girl-by-foundphotoslj

Financial Advice to Ignore – Even If You Get It From Your Mother!

1. Buy Low, Sell High. This advice has endured through the ages, most likely because it is so simple. The problem is in practice – if it were simple to know when is low for a particular security, and when is high, then of course everyone would follow this maxim. Unfortunately, fortunes are lost every day by folks attempting to Buy Low, Sell High.

Diversification – in time, asset classes, styles, tax treatment – coupled with cost reduction – is a much better way to go. If we must put a short, snappy phrase in play, perhaps it should be “buy a little at a time, all the time, until you need the money – and then sell only as much as you need, when you need it”. Doesn’t really fall off the tongue quite as easily, but you’ll find that the results are much more predictable, in your favor.

2. Hot Stock Tip! This one comes in many forms, including “Mutual Funds to Buy Now!”, and “My Broker Called Me About This Hot Opportunity!”. These are the kinds of “advice” that make good headlines, the kind that sell magazines, newspapers, and books.

You may receive this one in an unsolicited email, from a co-worker, in a financial magazine, via fax, or over the phone. These “opportunities” can range from former “winning” investments to the stock that the brokerage is paying the highest commission on at the moment.

Steadily gaining ground in your investment accounts by following a solid, well-diversified investing plan which is rooted in your goal plans isn’t sexy. But oftentimes the things that work best are pretty boring. It’s much better to be boring than wiped out by a wild ride on a questionable investment.

3. This is a Great Company! You Should Invest In It! Great companies don’t necessarily make great stocks. It seems simple: If you invest in only the best companies out there, your returns should be stellar as well. But great companies can falter, and if you pay too much for the stock, your returns may be less than great.

In the long run, you are probably much better off leaving stock picking to the pros – the managers of mutual funds – and investing in a broadly-diversified array of companies by using low-cost mutual funds.

4. Free Financial Plans. The advice may be free, but you will likely find it to be centered around the provider’s products. It just doesn’t make sense for a company to provide something of value for free, unless it is being provided in order to entice sales of their product.

Secondly, above and beyond the obvious conflict of interest issue, when financial advice or planning is free, chances are it is a “cookie-cutter” plan. I don’t know about you, but I’m pretty certain that my financial circumstances are unique – or at least I’d like to be treated as such.

5. Refinance Your Debt With a Home Equity Loan! Purveyors of this advice are not necessarily recommending anything bad – it’s just that human nature has a tendency to throw a wrench in the works. As with most of this list, there is a grain of truth to it, and a bit of value can be gleaned from it. The problem is in how the activity is approached.

In order to be successful at debt reduction, you need to understand how you got there in the first place. Perhaps it was college loans, or a health-related situation. Or maybe it was one (or several) too many pairs of “perfect pumps”. If you’re determined to stop the debt spiral, you need to take the first step of keeping the balances from climbing. In the case of a health-related issue, this may not be possible – but in most other situations, you can make strategic decisions to “stop the bleeding”. This may require taking some time off from school to work and cut down on some of your debt, or possibly cutting up all of those cards and avoiding the mall or online store, as the case may be.

As in all financial planning endeavors, the first step is to organize, to get a picture of exactly what you have (or what you owe, in this case). Tally up the balances. Look at that big number, and prepare to reduce it. Once you’ve determined just how big the balance is, take a look at the payments in total. Is your current rate of payoff making a dent? What are the rates of interest that you are incurring on the balances?

Having reviewed these numbers, you need to consider your resources. Do you have equity in your home that could be used to work yourself out of this situation? Caution is necessary here, because it is very easy (ask about half of the credit-card-holding population) to pay off your cards with an equity loan, only to charge up the balances soon afterward. It only takes one or two cycles of this to get yourself into a hole that is nearly insurmountable. This is why you must always consider “how you got there”, and use that information as a motivator to change those habits that caused the problem. Then (and only then) should you consider using your home equity to reduce the cost of the debt load, and therefore begin reducing the load itself.

Photo by foundphotoslj (and no, that's not my Mom, although
back in the day, my Mom's hair could rival that in the pic.)
Happy Mother's Day, Mom! :-)

Recharacterizing

May 8th, 2009
by jblankenship.
1 comment

big-cedar-tree-tiny-girl-by-woodleywonderworksFor IRA contributions, the concept is simple:  a certain amount may be contributed to the account each year, dependent upon the type of IRA and your MAGI (this is all covered here if you need a refresher).  But what if you find out that you are ineligible to contribute to a Roth IRA due to the MAGI limitation?  How about if you made contributions to a Trad IRA and, upon filing your taxes found out it would be in your best interest to put those funds in your Roth instead?  Enter the Recharacterization.

Recharacterization of IRA Contributions

This is a relatively simple process, but, as with most things, the Code makes it seem like rocket science.  Essentially, if you make a contribution to one type of IRA and then decide that you’d rather have it in the other type of IRA, you can affect this recharacterization by:

  • notifying both trustees (the original IRA and the second IRA) of the transfer
  • requesting a trustee-to-trustee transfer
  • include in the transfer any net income attributable to the contributions being recharacterized
  • report the recharacterization on your tax return for the year (Form 8606)
  • treat the contribution to the second IRA as if made on the date of the contribution to the first IRA (in other words, as if you had done it the right way the first time)
  • if the first IRA was a Traditional IRA, you are not allowed a deduction for that contribution for the tax year (obviously, since it wasn’t left there)
  • All of this has to happen before the due date of your tax return, plus 6 months – for most calendar-year taxpayers this is October 15. (see Footnote below  for additional info)

Wrinkles

Now, if you thought that was way too many steps to get something really simple accomplished, look at the following examples of additional confusion to add to the mix:

Conversion by Rollover from Traditional IRA to a Roth IRA… if you’re converting funds from your TIRA to the RIRA and the transfer occurs within two tax years (but still within the allowed 60 days)  you would treat the activity as having been completed before the end of the first tax year if you needed to later recharacterize the conversion.

Rollovers… if you’ve already made a tax-free transfer of the funds, in general those funds are not eligible to be recharacterized.

Recharacterizing Excess Contributions… since excess contributions must be removed prior to filing that tax return for the applicable tax year, any recharacterization of those amounts would have to be accomplished strictly by the due date of the return – no extra 6 months in this case.

Recharacterizing SEP or SIMPLE funds… if you’ve converted funds from a SEP-IRA or a SIMPLE IRA to a Roth IRA and wish to recharacterize those funds, they must go back to the type of IRA that they came from, either a SEP or a SIMPLE, but not a Traditional IRA.  But these can be new accounts if the old account was closed.

Mistaken Rollover to SEP or SIMPLE… if you mistakenly made a rollover transfer of Traditional IRA funds to a SEP or SIMPLE, you can recharacterize those amounts back into a Traditional IRA.

Employer Contributions… it is not allowed to recharacterize employer contributions to a SEP or SIMPLE plan as contributions to another type of plan.

NOT a Rollover… when considering the “once a year” restriction on rollover transfers, recharacterization is not counted as a rollover, so roll away!

No Reconversions (within limits)… if you converted from a TIRA to a RIRA and the recharacterized the conversion, you can not then re-convert those funds to the RIRA again in the same tax year, or within 30 days of the recharacterization (if after the end of the tax year).

Decedent… the election to recharacterize can be made on behalf of a deceased IRA owner by the executor, administrator, or other person responsible for the decedent’s final tax return.

So as you can see, there are lots of ways to complicate the process, but in general the act of recharacterization is pretty simple, as long as you follow the rules and pay attention to the dates.

Footnote: In this one case, the IRS allows additional time for completing the recharacterization activity even if you have not completed it by the prescribed dates.  There are some specific things that have to be accomplished in order to receive this extra time:

  • your return must have been filed on time
  • you must have done the following within 6 months of your filing date:
    • notify the trustees of the intent to recharacterize
    • provide trustees with all necessary information
    • request the transfer

Once complete, you must amend the return, write “Filed pursuant to section 301.9100-2” on the return, and refile with the recharacterization noted.  File the return at the same address as your original return.

Photo bywoodleywonderworks

Problems and (proposed) Solutions for 401(k) Plans

May 6th, 2009
by jblankenship.
4 comments

The 401(k) plan has been under a great deal of scrutiny lately, with quite a few proposals being offered to “fix” the system.  Granted there are a few problems with the system that is in place, but the overall concept is still good.  What follows is strictly my opinion of some of the real “problems” followed by a look at the presently proposed solutions that are being dallied about.

will-eat-for-food-by-altemark

The Problems With 401(k) Plans

Note: for the purpose of this discussion (and most discussions here) the term 401(k) is used to refer to all CODA (Cash Or Deferred Arrangements) such as 403(b), 457, etc.. In my opinion all these plans should be treated equally.

Problem: To start with, it makes so very little sense to strictly tie the plan to the employer.  Of course, this made a lot of sense when employer matches could be solely in company stock (a la Enron), but these days the whole concept is outdated.

Solution: Do away with the present system of tying the plan to the employer.  Instead, simply increase the annual limits on IRAs to the same limits for 401(k)s – let all folks take part in these plans.  Employers could still have the tax benefit for matching funds, but the “portability” issue would be gone, as would the need for all these rollover activities.  Level the playing field, making the rules that are currently IRA- or 401(k)-specific apply to the new IRA plan.

Problem: 401(k) plans have limited investment choices, many of which are inappropriate or inadequate for the investor’s situation and goals.

Solution: Under the “new IRA” option I mentioned above, the field would be open to all investments available from your custodian.  Custodians would soon learn to allow investments in virtually all available securities, as the investor can easily “vote with his feet” and move elsewhere with better choices.

Problem: There is no “guaranteed income” choice available in the 401(k). Since the original intent of the 401(k) was to replace the defined benefit pension plans – you know, the kind of pension where you’re guaranteed an income, often inflation-indexed, for life – it seems like you should be able to emulate that in a 401(k) plan.

Solution: There have been a few suggestions on the table in Congressional committee where annuity products would be made available for 401(k) investments.  The problem here is that, unless we’re talking about the lowest of low-cost providers (and there are a few out there), annuities are traditionally a very costly way to save and invest for the future.

I can’t argue with the sentiment, a guaranteed income choice would be perfect for a high percentage of folks – unfortunately this whole concept sounds too much like Social Security, and I don’t think we want to have two systems like that going in parallel. This option is still open for debate, in my opinion.

Problem: Most folks who have a 401(k) plan don’t have a clue about investing, and don’t have access to affordable, unbiased, professional advice.

Solution: This was actually addressed to a degree during the previous administration with the Pension Protection Act, but apparently the legislation’s carrot wasn’t enticing enough to get the ball rolling.  In addition, the previous legislation did not go far enough and label the advisor as a fiduciary – a step that I believe is critical to the long-term success of the investor.

Some of the proposals on the table now have taken the step to require fiduciary advisors.  The problem now is to get companies to implement this option.  Mandating is it probably going too far, but offering tax cuts or other benefits may be useful in giving this some traction.

Conclusion

This wasn’t intended to be an exhaustive list of the issues and solutions, just a list of the top things I’d been thinking about lately.  As I indicated before, I don’t think we need to toss out the baby with the bathwater; the 401(k) plan isn’t broken, it just needs a few adjustments.  Maybe you’ve got a few additional ideas, or suggestions to improve what I’ve tossed out here – I’d love to hear them.  Leave your ideas as comments below.  Thanks!

Photo by altemark

IRA Distribution Pro-Rata Rule

May 5th, 2009
by jblankenship.
No comments yet

rata-tree-by-grahamanddairneContinuing the discussion of IRA distributions, it is important to understand the Pro-Rata rule – which comes into play when you have both deductible and after-tax contributions in your Traditional IRA account. As you take distributions from the account, each distribution is treated as partly taxable and partly non-taxable, in proportion of the after-tax contributions related to the overall account balance.

So How Does The Pro-Rata Rule Work?

For an example, let’s say you have a Traditional IRA (TIRA) with a balance of $100,000.  Over the years you made both deductible and after-tax contributions to this account… and your after-tax contributions amount to $25,000.  It’s not necessary to know the amount of the deductible contributions (for this exercise), just the after-tax contributions.

For this tax year, you’ve chosen to take distribution of $10,000 from your TIRA.  When  you prepare your tax return next year, you’ll include $7,500 in ordinary income, excluding the $2,500 which is the proportionate amount of your distribution representing your after-tax contributions.  In this example, one dollar out of every four is considered return of your after-tax contributions.

That’s pretty simple, right?  So why is this deemed worthy of a whole blog post?  Hold your horses, I’m about to tell you…

Why This Is Worthy Of A Whole Blog Post

This is especially important when planning your Roth IRA conversions – which may be a significant activity for many in 2010.  When you do the conversion, this is essentially a distribution from your TIRA, and as such you are liable for ordinary income tax on the taxable portion of your distribution.

This is one of the reasons that financial advisors often recommend that, if you’re going to make non-deductible contributions to a TIRA with the intent to convert the account to a RIRA, that you make them in a completely seperate account.  This way, the only portion that would be taxable at the distribution (conversion) would the be the growth of the funds, such as capital appreciation and dividends.

But I didn’t pay attention…!

Now, if you’ve thrown caution to the wind and made both deductible and after-tax contributions to the same account, or if your account has grown significantly, there is still a way to convert only the after-tax amounts to a Roth IRA, but there are some restrictions as well.  

If you have access to a 401(k) plan or other employer-sponsored retirement plan (other than an IRA) that will accept rollover amounts (you’ll have to check this with your plan sponsor, some do not accept rollovers), you are allowed to rollover the amount from your IRA that represents everything but your after-tax contributions.  If you can pull this off, then you can convert the remainder amounts to your Roth IRA without a taxable event.  Pretty cool, huh?

All of these transactions can carry significant tax penalties if you make a mistake, so you need to be doubly sure that you’re doing it right before you make a move.  There are no “do overs” for these transactions (well, not without jumping through hoops or other places that you don’t want to consider).  Consult your tax advisor to make sure you’re doing it correctly if you’re not sure.

Photo by GrahamAndDairne

Investing Rules Article from WSJ

May 4th, 2009
by jblankenship.
No comments yet

protecting-the-bull-by-ynskjenIn the Wall Street Journal today there is an article by Mr. Brett Arends, discussing the rules for investing in the “next bull market”.  Mr. Arends frequently dispenses practical and useful advice, and this article is fits into that category.

The advice he offers is among the hallmarks of investing during any period – especially if you’re generally optimistic about the market in the long run.  Most individual investors would be very well-served to follow this advice.  Essentially he is saying:

  • be truly diversified in your investments – make sure you’re spread out among asset classes, time, tax treatment, and geopolitical sectors
  • don’t get caught up in the trends – when everyone is buying may not be the time to buy more; when the broker/salesman insists that you’re losing money by standing still, perhaps you should stand still.
  • practice patience – investing is not a “home run” or “get rich quick” activity
  • use your head – if you don’t understand the investment or why the investment is a good choice at this time, back away.  There are plenty of alternatives to consider.
  • have a strategy for rebalancing and/or changing your allocation mix.  Choices you made for investing five years ago will likely not be exactly the same as you would make today.  It pays to stick with a strategy, but it also makes sense to review and reassess your position from time to time.

All in all, a very good list of tenets to keep in mind – regardless of whether you believe this is the “next bull market” or not.  Plenty of money is made during all economic times in various investment activities; don’t feel like you’ve got to time your entry based upon what the evening news reports as a great time to invest.  By the time the news makes it to the general public, it may be too late in the game.  

As an example, as of this writing, emerging markets sector investments have built up a 28% gain in the last 90 days – and all the news has been about how awful of a time it is to invest.  A diversified portfolio would have done pretty well in the past few months, in spite of the news.

So what do you think?  Do you have a list of rules that you follow in your investment strategy?  Are they different from the guidelines I’ve listed above?  Tell us about them!

19 Ways to Withdraw IRA Funds Without Penalty

May 2nd, 2009
by jblankenship.
3 comments

10002248We’ve covered a lot of ground on how you can get at your IRA funds in this blog, but here is an all-inclusive list of the ways I’ve come up with to withdraw your funds without triggering the 10% penalty.  This list is for Traditional IRAs only.

It is key to note that, although these exceptions allow the distribution of funds without triggering the 10% penalty, in most cases the account owner would still be liable for the ordinary income tax on distributions.  Consult your tax advisor for additional information.

19 Ways to Withdraw IRA Funds Without Penalty

We’ll start with the obvious:

1. Normal – Begin after age 59½
2.  Before Tax Due – Withdraw annual allowed contributions before the due date of your tax return – an example would be to withdraw your 2008 contributions (and any associated growth) before April 15, 2009.
3.  Excess Contributions – Withdraw excess contributions before the due date of your tax return – if you discovered that you had contributed more than allowed (due to income limits or error) you are allowed to remove the excess and any associated growth before the tax return is due for the year.
4.  Required Minimum Distributions – technically this one is covered by #1 above for most circumstances, but sometimes RMD is required of a person who has inherited an IRA, regardless of age.

Now we’ll move into some of the not-so-obvious methods, starting with SOSEPP.

Series Of Substantially Equal Periodic Payments

This is the classic Section 72(t) method for withdrawing funds without penalty.  Essentially you agree to continue taking the same amount from your IRA for the greater of five years or until you reach age 59½. There are three methods of SOSEPP:

5. Required Minimum Distribution method – uses the IRS RMD table to determine your Equal Payments.
6. Fixed Amortization method – in this method, you calculate your Equal Payment based on one of three life expectancy tables published by the IRS.
7. Fixed Annuitization method – this method uses an annuitization factor published by the IRS to determine your Equal Payments.

Additional Section 72(t) methods for taking distribution from your IRA include:

8. Qualified Higher Education Expenses – you can withdraw your IRA funds to help pay for college
9.  Death – If you die, your beneficiaries are able to take distributions from your IRA without penalty.
10.  Disability – If you are “totally and permanently disabled” by IRS definition, you can take distributions from your IRA without penalty.
11.  High Unreimbursed Medical Expenses – for yourself, your spouse, or your qualified dependent.  If you face these expenses, you are allowed to withdraw a limited amount (the actual expenses minus 7.5% of your AGI) without penalty.
12.  Medical Insurance Premiums – if you’ve lost your job and receive unemployment compensation, you are eligible to withdraw an amount to pay for your medical insurance premiums (with some additional limits).
13.  First-Time Home Purchase – up to $10,000 ($20,000 for a couple) of the costs of buying, building, or re-building a “first home”.  First home is determined if you had no present interest in a main home for two years prior to the purchase.

And lastly, here are a few additional ways that you can withdraw your IRA funds without penalty:

14.  Qualified Reservist – If you were called to duty after September 11, 2001 and serve for at least 6 months, you are allowed to make a withdrawal from your IRA during your active duty period without penalty.
15.  Divorce – although not a particular IRS regulation, multiple Private Letter Rulings have allowed divorced parties to “split” an IRA into two separate IRAs, both with the original restrictions on distribution.
16.  Roth IRA Conversion – when you convert your funds from a Traditional IRA to a Roth IRA, although you pay tax on the distribution, there is no 10% penalty applied.
17.  Rollover – using the 60-day period, you are eligible to have access to your funds without penalty as long as the rollover is completed within 60 days.
18.  Payment to Advisor/Investment Manager – you are allowed to authorize your custodian to pay your Advisor or Investment Manager from your IRA funds any fees for managing your IRA. This includes transaction fees and annual custodian fees.
19. Periodic Temporary “Relief” provisions – from time to time, as the situation merits, Congress will enact special legislation allowing individuals impacted (primarily) by natural disasters to access IRA funds without paying the 10% penalty. One notable example of such a provision was for victims of Hurricane Katrina.

Now, did your list have 25 different ways?  Perhaps I’ve overlooked some… let me know if you have other ways in your list that folks can withdraw IRA funds without penalty. Let me know what you think!

For additional information on most of these methods, see the IRA Owner’s Manual or click the IRA Owner’s Manual link at the top of the page.

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