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Early distributions from traditional IRAs

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By Doug Awad

In Part I we reviewed some exceptions that allow early distributions from a traditional IRA without incurring the 10 percent income tax penalty. This article will cover other important information about traditional IRAs.

Should you take distributions from your traditional IRA before age 59? You are allowed to take distributions from your traditional IRA whenever you like in any amount you choose.

That does not mean, however, that you should take distributions. As a general rule, it is not advisable to take distributions from a traditional IRA before age 59 (or for that matter, at any age prior to your retirement).

First, the portion of the distribution that goes to the federal government for taxes can be substantial – not to mention state taxes (if applicable) and penalties.

This is especially true if the entire distributions will be taxable, and if none of the exceptions to the premature distribution tax apply to you.

In addition, even if all or some of the distribution will not be taxed or penalized, taking IRA distributions before age 59 is still generally not wise. By dipping into your IRA funds at a relatively early age, you run the risk of depleting those funds sooner than you had anticipated.

This could jeopardize your retirement goals and financial security later in life. Funds removed from an IRA may also be missing out on several years or more of potential tax-deferred growth, depending on investment performance.

However the decision of whether to tap into your IRA nest egg ultimately depends on your individual circumstances. Perhaps you have urgent expenses, and withdrawing from your IRA is the only way you can pay them.

It is also possible that you have accumulated large balances in your IRAs and other investment accounts, so that withdrawing from your IRA will not pose a risk to your future financial security. In these cases, taking distributions before age 59 is not necessarily ill-advised.

Whatever your situation, though, you should consult a tax professional before taking a distribution.

IRA rollovers: In general, a rollover is the movement of funds from one retirement savings vehicle to another – in this case, from one traditional IRA to another. Rollovers are treated separately from contributions: you are still allowed to make your regular IRA in a year when you have a rollover transaction.

There are no age restrictions regarding rollovers but there are specific rules that must be followed. For example, a rollover generally must be completed within 60 days of the date the funds are released from the distributing account.

If properly completed, rollovers are not subject to income tax or the premature distribution tax. There are two possible ways that IRA funds can be rolled over.

You receive funds and reinvest them: With this method, you actually receive a distribution from your traditional IRA.

To complete the rollover transaction, you must make a deposit into the IRA that you want to receive the funds. You are allowed to do this only once in a 12 month period.

If you receive second distribution from the same IRA within a 12-month period, you cannot roll it over (you also can’t make a rollover from the IRA you roll the funds into for 12 months). Also, you must deposit the full amount distributed to you within the 60 day rollover period.

If you fail to complete the rollover or miss the 60 day deadline, all or part of your distribution will be subject to income tax and possible the premature distribution tax.

Trustee-to trustee transfer: The second type of rollover transaction occurs directly between the trustee or custodian of your old traditional IRA and the trustee or custodian of your new traditional IRA.

You never actually receive the funds or have control of them. A trustee-to-trustee transfer is not treated as a distribution and avoids the danger of missing the 60 day deadline. You are also not subject to the “once per 12 month” limitation.

This is generally the safest and most efficient way to move IRA funds. Taking a distribution yourself and rolling it over only makes sense if you need to use the funds temporarily and are certain you can roll over the full amount within 60 days.

If you have questions, call Doug Awad at 854-6866, or e-mail Doug.Awad@raymondjeames.com. He is a resident on the 200 Corridor and his office is on 31st Road, adjacent to Paddock Mall.

Portions of this information were developed by Forefield, Inc., an independent third party. It is general in nature, is not a complete statement of all information necessary for making an investment decision, and is not a recommendation or a solicitation to buy or sell any security.

Investments and strategies mentioned may not be suitable for all investors. Past performance may not be indicative of future results. Raymond James & Associates Inc. does not provide advice on tax, legal or mortgage issues. These matters should be discussed with an appropriate professional.