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EARLY WITHDRAWAL.

RICHARD PEACE RECALLS THE TIME ONE OF HIS clients was just fed up with her job. "It happened last year," says Peace, a certified financial planner in Colorado Springs, Colorado. "She was unhappy at work, she was having some health problems and she wanted to spend some time with her young grandchildren. So, she quit her job."

At this point, the grandmother, age 51, needed money for living expenses. "The only asset she could use was her IRA, in which she had accumulated about $75,000. I worked with her and determined she could get by if she pulled out $600 per month, more than $7,000 per year," recalls Peace. "This would leave the rest of her IRA to keep growing."

One of the great temptations that can wreck your retirement is pulling money prematurely from your individual retirement account, 401(k) or 403(b) plan. You know the money is being set aside tax-free to finance your retirement, but the desire to withdraw the funds can be substantial, especially if you're strapped for cash. But the price for pulling money out before you reach age 59 1/2 is pretty high: a 10% penalty and income taxes levied on that money to boot. Peace's client, who withdrew $7,000, might have had to pay a $700 penalty.

"Fortunately, there are several exceptions to the early withdrawal penalty, and my client was able to use one of them," says Peace. Normally, he doesn't recommend clients take money out of their retirement plan before 59 1/2, "but, if you absolutely have to, try to qualify for one of these exceptions and avoid the penalty."

Whether you are in an IRA, 401(k) plan or the nonprofit equivalent, a 403(b) plan, you can pull money out of your retirement coffers under certain dire circumstances: high medical expenses or disability (see table for additional information). These exceptions are explained in Section 72(t) of the Internal Revenue Code. In addition, if someone dies and names you as the beneficiary of a retirement plan, you can withdraw the funds and avoid the 10% penalty, no matter what your age.
IRA AND ROTH IRA WITHDRAWALS UNDER NEW TAX LAWS

 TRADITIONAL IRA

 Reason for 10% early
 withdrawal withdrawal penalty? Taxable?

 Higher No Yes
 Education
 First-Time No Yes
 Home Buyer
 Disability No Yes
 or Death
 For any Yes, but there Yes
other reason are some
 exceptions
 For any Yes
 reason

 FUNDS IN A ROTH IRA
 FEWER THAN 5 YEARS

 Reason for 10% early
 withdrawal withdrawal penalty? Taxable?

 Higher No On earnings,
 Education not original
 contributions
 First-Time No On earnings,
 Home Buyer not original
 contributions
 Disability No On earnings,
 or Death not original
 contributions
 For any On earnings, On earnings,
other reason not original not original
 contributions contributions
 For any On earnings,
 reason not original
 contributions

 FUNDS IN A ROTH IRA
 FOR 5 YEARS OR MORE

 Reason for 10% early
 withdrawal withdrawal penalty? Taxable?

 Higher No On earnings,
 Education not original
 contributions
 First-Time No No
 Home Buyer
 Disability No No
 or Death
 For any On earnings, On earnings,
other reason not original not original
 contributions contributions
 For any No No
 reason


PAYMENTS WITHOUT PENALTY

Peace's client bypassed the penalty by taking what are called "substantially equal periodic payments" from her

IRA under section 72(t) of the Internal Revenue Code, and it may be the one method most people can benefit from.

In general, 72(t) payments are based on your life expectancy. Once you start receiving funds using this method, they must continue for at least five years, or until you reach 59 1/2, whichever comes later. All Ilia owners can use the 72(t) election at any time, while participants in other plans can use the calculation after retirement or changing jobs. The application of 72(t) rules can vary, depending on your circumstances, producing different distribution amounts.

"There are three methods permitted by the IBS," says Peter Brennan, divisional vice president with Oppenheimer-Funds in New York City. "You can choose among life expectancy, amortization or annuitization."

By basing your periodic payments on life expectancy, you withdraw money based on tables established by the IRS. If your life expectancy is 30 years, for example, you'd calculate 1/30th of your plan balance and withdraw that much each year. Alternatively, you can name a beneficiary and withdraw an amount based on a longer joint life expectancy.

With amortization, you calculate that your initial plan balance will grow by a "reasonable" rate. "The Ills has indicated that you can assume an interest rate that's 120% of the current mid-term federal rate," says Brennan. "In today's environment, that might mean a rate of 6% or 7% or so. You can assume a higher rate if you can justify your expectation that the plan will grow by that amount." The higher the assumed rate, the greater the penalty-free withdrawals you're permitted. This technique permits much higher withdrawals than the life expectancy method.

As for annuitization, this is a more complicated calculation, incorporating annuity factors and present values. The end result: you can withdraw a bit more with this method than with the amortization method, depending on the circumstances.

What can you make of all this data? The use of the methods vary, so you can arrive at different numbers. If you need to take money from a retirement plan before age 59 1/2, calculate the amount that you'll need for living expenses. Don't forget to factor in the income tax you'll have to pay on withdrawals. Try to withdraw as little as possible in order to keep the balance growing, tax-deferred, to finance your retirement.

Once you have a figure for your desired stream of withdrawals, contact the bank, brokerage firm or mutual fund company that acts as the plan custodian. The custodian will assist in making the calculations and determine the method you should use to arrive at the chosen amount.

SPLITTING THE IRA DIFFERENCE

It is possible to split your IRA. Suppose, in the above example, you had a $150,000 IRA and you wanted to withdraw $750 per month. Using the life expectancy method would provide $378 per month (not enough), while using the annuitization method would provide $1,125 per month (too much).

In this case, you could break up your $150,000 IRA into a $100,000 IRA and a $50,000 IRA; then you could take distributions from the $100,000 IRA, pulling out a "just-right" Goldilocks figure of $750 per month from that account. The other $50,000 IRA can remain untouched to continue its tax-free buildup.

If you decide to receive periodic payments, keep in mind the five-year/59 1/2 requirement. "My client started to take these payments at age 51," says Peace, "so she'll have to keep up the withdrawal schedule until she reaches 59 1/2. Someone else, who starts at 58, would have to keep on the schedule until age 63."

Once you reach the appropriate milepost, 59 1/2 or have satisfied the five-year window, you can withdraw as little or as much as you want, penalty-free. However, a new set of minimum distribution rules kicks in after age 70 1/2.

What happens if you don't maintain the 72(t) payment method for five years or until age 59 1/2, whichever comes later? You'll owe the 10% penalty on all withdrawals, retroactively. Thus, once you get started, it pays for you to stay the course.

Try to withdraw as little as possible in order to keep the balance growing, tax-deferred, to finance your retirement.

DISABILITY AND MEDICAL EXPENSES

The broad exceptions to Rule 72(t)--disability and medical expenses--are worth knowing about, just in case one of these serious situations should befall you.

Disability. If you can't work, the 10% penalty won't be assessed. "In practice, if you're receiving a disability check, you probably can avoid the 10% penalty," says Lee Rosenberg, a financial planner in Valley Stream, New York. "That's true if you're receiving Social Security disability benefits or if you're receiving benefits from a disability insurance policy. One of my clients, a construction worker, hurt his back. His accountant attached [a document] to his tax return, explaining that he was receiving disability benefits from his union, and the 10% penalty was not enforced."

Medical expenses. "The 10% penalty will be waived in the case of money withdrawn up to the amount of deductible medical expenses," says Cory Grant, an attorney and estate advisor with Westhem Group Wealth Transfer Planning in San Diego, California.

Suppose you have adjusted gross income (AGO of $60,000 in 1999 and medical expenses of $12,0007 Deductible medical expenses start at 7.5% of AGI, or $4,500 in your case. Thus, you would be $7,500 over the threshold, so you could withdraw $7,500 from your retirement plan, penalty-free.

EMPLOYER-SPONSORED PLAN EXCEPTIONS

There are two other situations under which you can pull out funds, but these apply to employer-sponsored plans only: separation of service and qualified domestic relations orders.

In the former case, if you retire or change jobs, you can withdraw money, penalty-free, if the separation occurs during or after the year you reach age 55.

Then there are qualified domestic relations orders, or

QDROs. "In a divorce or marital separation, a QDBO is an order to the qualified plan's administrator to transfer part of one spouse's interest in the plan to the other spouse," says Andrew Fair of the law firm Fair, Aufsesser & Fitz-Gerald, White Plains, New York. "The 10% tax on withdrawals before age 59 1/2 does not apply to payments made to a spouse or ex-spouse under a QDRO."

There are some IRA-only loopholes as well, which can help people meet healthcare, education and real estate expenses.

Health insurance. If you are out of work for at least 12 consecutive weeks, you can take enough money from an IRA to keep your health insurance in force for 60 days, penalty-free, and keep doing so until you're back to work.

Education. Distributions from IRAs to pay post high school expenses are exempt from the 10% penalty. "Eligible expenses include tuition, room and board, fees, books, supplies and required equipment," says Ed Slott, a certified public accountant in Rockville Centre, New York, who publishes Ed Slott's IRA Advisor, a monthly newsletter. "Qualifying expenses can be yours, your spouse's, your children's, even your grandchildren's."

First home purchase. You also may take penalty-free withdrawals up to a lifetime amount of $10,000 for a first-time home purchase. To qualify, you cannot have had an ownership interest in a residence during the previous two years.

As for Both IRAs, exceptions to the 10% penalty "that apply to traditional IRAs also apply to Both IRAs," says Slott. "If you withdraw money from a Both IRA before 59 1/2 for other reasons, you'll owe the penalty on the amount that's ,attributable to your earnings inside the Roth IRA, but not to your original contributions."

But before you touch one penny of your retirement stash prior to your golden years, check with a financial advisor to make absolutely sure your situation qualifies for an exemption from the 10% penalty.

RELATED ARTICLE: DON'T PAY THE 10% PENALTY!

In general, if you pull money from your retirement plan before age 59 1/2, you'll get socked with a 10% early withdrawal penalty and you'll have to pay taxes to boot. But there are exceptions, some of which apply to all plans--like an IRA, 401(k), 403(b), or Keogh--and some of which apply only to employer-sponsored vehicles.

* Substantially equal periodic payments. Section 72(t) of the Internal Revenue Code allows you to withdraw money from your retirement plan on a regular basis. The calculations for these withdrawals must be based on your life expectancy to avoid the penalty. For example, if you're expected to live another 30 years, you'd calculate 1/30th of your plan balance and withdraw that much each year. Two other methods of figuring out these elections are amortization and annuitization.

Death. If someone dies and names you as the beneficiary of a retirement plan, you can withdraw the funds no matter what your age.

Disability. If you're severely injured and can't work, you can get money from your plan, This applies whether you're receiving disability checks from Social Security or from a disability insurance policy.

Medical expenses. You can withdraw money if the funds are used to pay medical expenses that exceed 7.5% of your adjusted gross income.

Separation from service. If you retire or change jobs, you can withdraw money if the separation occurs during or after the year you reach age 55.

Qualified domestic relations orders (QDROs). If you get separated or divorced, a portion of your or your spouse's retirement plan can be transferred to another plan, as part of the terms of a settlement. A QDRO is an order to effect that transfer.

First home purchase. You can withdraw up to $10,000 for a first-time home purchase. To qualify, you cannot have had an ownership interest in a residence during the previous two years.

Health insurance. If you are out of work for at least 12 consecutive weeks, you can take out enough money from your IRA to keep your health insurance plan in force for 60 days, and keep doing so until you're back to work.

Higher education. Distributions from IRAs can be used to pay post high school expenses such as tuition, room and board, books, fees and supplies.3
COPYRIGHT 1999 Earl G. Graves Publishing Co., Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1999, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

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Title Annotation:penalties on retirement plans
Author:KORN, DONALD JAY
Publication:Black Enterprise
Geographic Code:1USA
Date:Nov 1, 1999
Words:2257
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