One of the best ways to have enough
money for retirement is to contribute to your IRA and
leave it alone -- let the money grow. Take advantage
of compounding interest and deferred taxes and, ideally,
if you started the plan early enough you won't have
to find a part-time job asking, "Paper or plastic?"
when you're 70.
But if you want to
retire early -- or if you're seriously strapped for
cash and need to tap your IRA money -- there's a way
to do it without triggering a penalty.
For the most part, if you take money out
of an IRA before age 59½, you have to pay a 10-percent
penalty on top of ordinary income taxes.
Avoiding the penalty
The exception is if you take the money out in "substantially
equal payments" over your lifetime. Internal Revenue
Service rules require that you take at least one payment
annually for the exception to apply. Actuarial tables
are used to determine life expectancy and, in essence,
you're turning your retirement plan into an annuity,
also called an "annuity distribution," or
for the truly bureaucratic, "annuitizing an IRA."
Certified public accountant Darryl Hinkle
of Hinkle & Richter in Pompano Beach, Fla., says
he's seen very few people take advantage of this --
and for good reason.
"Say a 35-year-old guy has $100,000
in an IRA. He decides to take the money out. He'd have
to take it out over 40 years -- so, he'd take $2,500
a year. This limits the ability for that money to grow.
You have to swallow hard when you go into one of these
Furthermore, if our 35-year-old guy decided
a couple of years later that he didn't need the $2,500
and wanted to reduce his payments to $2,000, the IRS
would slap him with the 10-percent penalty. The rules
say you can't change the payment plan for five years
or until you reach age 59½, whichever is later.
a difference, too
If a husband and wife take the payments out together
and one spouse dies before age 59½ or before
they've had the account open for five years, the surviving
spouse can adjust the payments based on his or her own
life expectancy without penalty.
Hinkle says there are circumstances where
it might make sense to take such an annuity distribution
on a retirement plan.
"If someone's in their 50s and lost
their job, he might say, 'I've got a half-million dollars
here and I need to tap into it. What the heck, I'll
start now.' That's more conceivable."
The annuity distribution can be set up
as a one-life annuity or a two-life annuity for married
couples. If it's a one-life and the person is 55 years
old, according to the actuarial table that person will
live an additional 28.6 years. If it's a two-life, based
on the life expectancy of both spouses, the table says
both will have died within 34.4 years. Simplified, if
you have a $500,000 IRA and you opt for the single-life
table you divide $500,000 by 28.6 for an annual payment
of $17,482.52. Using the two-life annuity, you divide
$500,000 by 34.4 for an annual payment of $14,534.88.
Be aware there are other situations that
will qualify you to take money from your IRA without
a penalty before you hit 59½. They include disability,
buying a first home and paying medical expenses that
exceed 7.5 percent of your adjusted gross income. If
you're interested in tapping your retirement fund early,
check with the IRS or your accountant to see if your
account and situation will qualify.
Affected by Katrina?
If you live or lived in the Hurricane Katrina zone,
you could qualify for a new exception to the withdrawal
"This year, with Katrina, they've
changed the IRS rules regarding IRAs for people who
live in the Katrina zone," says Hinkle. "They
can withdraw, after Aug. 25 of 2005 and before Jan.
1, 2007, up to $100,000 from any IRA without penalty."
Withdrawals are still subject to any applicable
income taxes, he says. But account holders can also
elect to spread that withdrawal income over three tax
years. For example, "say you took out $100,000
to rebuild your house, you can recognize one-third of
the withdrawal on your 2005 return, one-third on 2006
and one-third on 2007."
Anything over $100,000 would be subject
to the normal 10-percent penalty, he says.
Says Hinkle, "The intent of
the law is to enable people who lost their job, lost
their home, don't have enough insurance, to take out
enough to get their lives back together without having
to pay a penalty."