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October 13, 2012

THOMAS SEITZ | Careful tapping retirement account early

THOMAS SEITZ For The Tribune-Democrat The Tribune-Democrat Sat Oct 13, 2012, 11:04 PM EDT

— In case of emergency, you may need to withdraw funds from one of your retirement accounts. What are the tax consequences?

It depends on several factors, including your age, the type of account, and the use of the funds.

Here are the basic rules.

Distributions from traditional IRAs and qualified plans, such as a 401(k), are taxable at ordinary income rates.

The tax applies to the portion of the distribution representing deductible contributions and earnings. Currently, the top federal income tax rate is

35 percent, but it’s scheduled to increase to 39.6 percent in 2013.

In addition, if you are younger than 59½, you will owe a 10 percent penalty tax on top of the regular income tax, unless a special exception applies. The following exceptions apply to both IRAs and qualified plans:

• Payments made due to death or disability.

• Substantially equal periodic payments for the longer of five years or until you reach age 59½.

• Withdrawals to pay deductible medical expenses.

• Distributions to satisfy an IRS levy.

Some exceptions are available only for IRA distributions. This includes withdrawals used to pay first-time homebuyer expenses (lifetime limit of $10,000), higher education expenses or health insurance for the unemployed.

The exceptions limited to qualified plans include distributions made after age 55 if employment is terminated and distributions made under a “qualified domestic relations order” in divorce situations.

Also, separate rules apply to Roth IRA distributions.

Qualified distributions from a Roth at least five years old are completely tax-free. For this purpose, “qualified distributions” include those made after age 59½, due to death or disability, or to pay first-time homebuyer expenses (lifetime limit of $10,000). Otherwise, distributions are taxed under special “ordering rules” with tax-free contributions treated as coming out first and taxable distributions last.

The tax rules on early distributions are complicated. For more information about the tax consequences of taking withdrawals from your retirement accounts, contact a certified public accountant.

Thomas Seitz is a certified public accountant with Wessel & Co. of Johnstown.

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