Understanding the 59 1/2 Rule for IRA Withdrawals

Understanding the 59 1/2 Rule for IRA Withdrawals

By Cathy DeWitt Dunn

Retirement accounts come in many forms and offer numerous benefits, ranging from tax breaks to tax-free growth throughout the formative years of your career. Individual Retirement Accounts, better known as IRAs, can provide extensive advantages after the conclusion of employment. Millions of Americans take advantages of IRAs, but this doesn’t mean that they understand how they work.

Many people believe that once retirement hits, retirement accounts are accessible free and clear. This, unfortunately, isn’t the case. There are many rules that govern access to IRA accounts, with age being one of the most important factors in distribution.

Please note that in the discussion below, the information is provided for educational purposes only. It should not be relied upon for tax advice. Please consult with a tax specialist for information and details related to your specific situation.

Your IRA, the Tax Code, and You

Taxes in the U.S. are undeniably complex, a fact that is especially true when it comes to investments. Although many of these factors, such as taxable gains and losses, do not apply to IRAs, which grow tax-free, this does not mean that tax complications can be avoided by investing in retirement accounts.

In order to guarantee that the benefits of IRAs are used solely for retirement, the IRS imposes age limits on these accounts. Unless users are willing to incur a 10% penalty, IRA assets are not accessible until age 59 and a half. There are exceptions to this rule, as is the case with most IRS policies, but this doesn’t mean that the alternatives are easier.

The 55-Year-Old Rule

So you’re 55 and decided to retire. Now what? Luckily, there’s an option for you. The age 55 rule applies to individuals who choose to terminate employment in the year of their 55th birthday or older and are thus eligible to take a distribution from a company retirement plan without being subject to the 10% penalty.

This policy applies only to calendar years, not 365 days surrounding one’s 55th birthday. It is also limited only to company accounts and not IRAs, regardless of rollovers into other accounts. Is it logical? Not really, but the IRS rarely is.

The 72(t) Payment Rule

72(t) payments allow IRA-holders to take distributions for the five years subsequent to when the holder turns 59 and a half. As simple as this sounds, however, the actual practice is much more complicated.

In order for the 72(t) payment rule to apply, equal distributions must be taken for at least five years, or until the holder is older than age 59 and a half. If a year is skipped, or the distributions terminate within the five years before the holder turns 59 and a half, the 10% penalty is applicable.

The Roth Conversion and Distribution Rules

One of the best ways to avoid paying tax on your IRA distributions is to convert your traditional IRA into a Roth IRA. This method is generally favorable, although upon conversion, tax may be due on the gains generated between the funding of your IRA and the conversion date.

Converted Roths cannot, however, be accessed right away without penalty. Incidentally, this rule also applies to all Roths. In order for a Roth IRA to be eligible for distribution of any kind, it must be held for at least five years after the first day of the calendar tax year in which the conversion or initial contribution took place, or until the holder turns 59 and a half. If distributions are taken before this time, the tax-free distribution feature of Roth IRAs is not enforced and distributions will be both taxable and subject to penalties.

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Required Minimum Distributions for Non-Spousal Beneficiaries

Required Minimum Distributions, or RMDs, are required of all IRAs after age 70 and a half. If the beneficiary of an IRA is not a spouse, however, and the holder passes away, RMDs must be taken prior to December 31st of the year after the holder’s death, regardless of the holder’s age.

Managing Your IRA

IRAs are among the most valuable tools for retirement, provided they are used properly. Navigating the rules governing these accounts may be complicated, but understanding the policies surrounding ages and distributions can be advantageous.

Making the most of an IRA isn’t easy, but it can be extremely beneficial under the right circumstances. When you want to save for retirement, an IRA can be a great tool, no matter how you choose to use it.

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