Premature Retirement Distributions

 

By Jon Flynn

 

The divorce was finally official.  While still emotionally upset with the end of her marriage, Sara was also deeply concerned about being able to pay the monthly bills on her own.  Like many couples, she relied on her husband Bill’s salary to make ends meet.  Yes, she would receive some alimony, but it wasn’t nearly enough.

 

She was a stay-at-home mom all her adult life, and now, a woman in her early fifties, the prospect of finding a good job wasn’t the best.  She would need more money to cover the bills than just a low paying job or a small alimony check could provide.  Fortunately, she thought, Bill had a large IRA that was divided equally among them in the divorce settlement.  As a result, half of his IRA account balance was placed in an IRA account in her name.  She thought, maybe she could tap into this new IRA to help out for a while until things got better.  Suddenly she remembered hearing that there might be penalties involved if she wasn’t old enough to take a distribution from an IRA. 

 

She felt confused and desperate.  Was there anything she could do to get around the penalty? Let’s take a look?

 

She was right about the penalty; the IRS does levy a 10% penalty if an individual makes a “premature” withdrawal - that is a distribution made prior to age 59 ½.  However, the IRS fortunately allows for some exceptions.  The most traditional ones I’ll note are:

 

1.)    Health insurance premium payments for unemployed individuals,

2.)    Death of the account owner,

3.)    Payments of medical expenses in excess of 7.5% of an individual’s adjusted gross income,

4.)    Qualified first-time homebuyer,

5.)    Higher educations expenses,

6.)    IRS levy,

 

And finally the one that can help Sara…

 

7.)    Part of a series of substantially equal periodic payments. Rule 72(t).

 

Allow me to briefly explain how the “substantial equal payment” rule works.  The IRS says that you can take distributions from your IRA and avoid the 10% penalty if you stick to the following, 1.) You take distributions at least annually, 2.) In an amount determined by one of three approved methods, and 3.) Continue until you are age 59 ½ or for five years, whichever comes later.

 

Let me translate what this means for Sara.  Bottom line, this allows Sara to draw a check from her IRA account to supplement her alimony and working income. Obviously, with people living as long as they are today, I’m always concerned when somebody taps into their retirement accounts too early, but in this case it allows Sara some time to pull her life back together.  This strategy definitely comes with some “fine print”.  It can also be complex to set up and difficult to make changes to.  So I strongly urge that you only work with a professional if you think it can help your situation as well.

 

Everybody’s situation is different and arriving at solutions can get complicated.  So always consult with financial, legal, and tax professionals before making any decisions.   Distributions modified (except for death or disability) before the longer of five (5) years or age 59 ½, will be subject to the 10% penalty tax plus interest.   Past performance is no guarantee of future performance.  There is a risk that the principal balance of the client’s account could be exhausted in the event that the distributions exceed the net earnings and growth of the investments.  Clients who live beyond their normal life expectancy may find their account values have been completely depleted.  The 72(t) distributions are subject to the federal and state income taxes. Please consult a tax advisor for specific tax advice.

 

 

Jon Flynn is a Certified Financial Planner ^TM and owner of Flynn Financial in Eynon. He is a Representative of Securities America, Inc., Member FINRA/SIPC and of Securities America Advisors, Inc. Flynn Financial and Securities America are unaffiliated.   Mr. Flynn can be reached at 570-876-5015.