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Question: Can I make penalty-free IRA withdrawals?

Answer: The tax law generally makes you pay a 10% penalty if you take money out of an IRA before you reach age 59½. However, there are several ways to tap your IRA earlier without incurring the 10% penalty.

  • Equal withdrawals. One way is to elect to take substantially equal withdrawals based on your life expectancy or the joint life expectancies of you and your designated beneficiary.
  • Home and education. You may also take money from your IRA to help cover certain expenses. For example, if you, your child, or grandchild is purchasing a home and the purchaser hasn’t owned a home within the last two years, you can withdraw, penalty-free, up to $10,000 to use towards this transaction. Likewise, if you, your spouse, child, or grandchild attends college or graduate school, you can take penalty-free distributions to cover eligible higher education costs.
  • Medical expenses. The IRS also allows penalty-free access to IRAs when taxpayers face certain difficulties. For example, if your medical expenses exceed 10% of your adjusted gross income, you may make a penalty-free withdrawal of up to the amount by which these expenses exceed the 10% floor. Similarly, if you have been unemployed for at least 12 consecutive weeks, you can take a penalty-free distribution to cover medical insurance premiums. Also, you are exempt from the early withdrawal penalty if you become disabled.
  • Military and public service personnel. Special rules apply to those on active military duty and to certain public safety employees.

Remember that you will most likely owe regular income tax on the money withdrawn even if the withdrawal is penalty-free.

Question: Can my child set up an IRA?

Answer: If your child has wages or self-employment income, he or she can contribute to an IRA. However, in 2014 the contribution cannot exceed the child’s earned income or $5,500, whichever is lower.

Your child can choose between making a deductible IRA contribution and a nondeductible Roth IRA contribution. In most cases, a Roth IRA will have the greatest long-term benefit for your child.

Question: I contributed money to a regular IRA but because I’m covered by an employer’s pension plan at work, I was told I can’t deduct my contribution. I want to set aside money for retirement. What should I do?

Answer: There are two choices you should consider. First, you can leave your contribution where it is. You can’t deduct the contribution since you are covered by an employer’s plan and your income exceeds certain limits. But your investment will grow tax-deferred inside the IRA, and you won’t have to pay tax on your nondeductible contribution when you withdraw it someday.

Your second choice is to “recharacterize” your contribution. That’s what the IRS calls changing your regular IRA contribution to a Roth contribution or changing a Roth IRA contribution to a regular contribution. You generally have until October 15 to get your contribution (and the earnings on it) recharacterized. With a Roth, your contribution is not deductible, but the entire amount that accumulates inside the Roth can be withdrawn tax-free if you follow the rules.

Question: Once I turn age 70-1/2, how much money must I withdraw from my traditional IRA account each year?

Answer: The amount you must withdraw from your IRA each year is called your required minimum distribution (RMD). Using an IRS chart, you select a factor based on your age, and divide that factor into your prior year-end retirement account balance. The result is the amount you must withdraw for the current year.

Note: Withdrawals at age 70-1/2 are not required for Roth IRAs.

Question: Should I convert my IRA to a Roth IRA?

Answer: Roth IRAs are very attractive because once money is inside a Roth, it may never be taxed again. However, before you rush to convert your traditional IRA to a Roth, there are a number of factors you should consider.

  • How much after-tax money will you end up with for retirement? You’ll need to make some assumptions about your future tax rate, your retirement age, and your investment return. Then you’ll have to run the numbers to see whether you’d end up with more money, after taxes, if you left it in your traditional IRA or if you converted to a Roth.
  • Do you have enough cash to pay conversion taxes? When you convert, you’ll owe regular income taxes on the amount you roll over to your Roth. If you have to sell outside investments to pay taxes on the rollover, you’ll owe taxes on any gains from those sales as well. If you have to cash out part of your IRA to pay taxes, you’ll be socked with a 10% penalty unless you are over 59½.
  • How soon will you need the money? Generally, you cannot withdraw the earnings on the money within five years of the conversion without a penalty.
  • Will the conversion income push your adjusted gross income to the point where it will cost you valuable tax benefits, such as certain deductions and tax credits?
  • Will it push you into a higher tax bracket?

As you can see, deciding whether a Roth conversion is right for you involves careful planning.

Question: What if I fail to take my required IRA distribution on time?

Answer: You’ll face a 50% penalty on the amount that should have been withdrawn.

Question: What investment choices do I have for my IRA?

Answer: The tax law only tells you what investments can’t be held inside your IRA. You may not use IRA funds to invest in collectibles such as artwork, rugs, antiques, coins, stamps, and gems. The law also prohibits IRA investments in life insurance, tangible personal property (such as a car), and non-U.S. property.

Clearly, that leaves you with a lot of investment choices. Conventional IRA investments include publicly traded stocks, bonds, mutual funds, Treasuries, or cash. More unconventional investment options include:

  • Certain gold, silver, and platinum coins and bullion
  • Commodities and futures
  • Real estate
  • Mortgages/deeds of trust
  • Promissory notes
  • Limited partnerships
  • Joint ventures
  • Private stock offerings
  • Foreign stocks
  • Limited liability corporations
  • Tax lien certificates
  • Accounts receivable
  • Commercial paper
  • Leases

Question: When must I start withdrawing money from my IRA?

Answer: Upon turning age 70 1/2, you must begin withdrawing money from your traditional IRA as follows:

— Your first withdrawal can either be taken by December 31 of the year you turn age 70 1/2, or it can be postponed up until April 1 of the following year.

— Your second withdrawal must be taken by December 31 of the year after you turn age 70 1/2.

— In each subsequent year, you must withdraw at least the required minimum amount by December 31.

If you fail to take your required distribution on time, you’ll face a 50% penalty on the amount that should have been withdrawn.

Note: There is no requirement to make withdrawals from a Roth IRA at age 70 1/2.

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