Understanding Traditional IRA Distributions Through the Game of Golf

I am a stout believer that everything in life can be understood through the game of golf. Distributions from a traditional individual retirement account (IRA) are no different. Traditional IRAs are meant to supplement retirement income. Thus, the expectation of par with a traditional IRA is that no distributions occur before age 59 1/2. It is intended to discourage early withdrawals with a shot penalty of 10% applied to an early withdrawal. While distributing from traditional IRAs after reaching age 59 1/2 may seem as simple as scoring par, there are exceptions and tax incentives that can benefit IRA owners. It is important to note these distributions to ensure you are maximizing the benefits of your IRA. 

Distribution Exceptions 

The best way to remember an exception is that they are like mulligans; with mulligans, there is no penalty. For the following distribution types, you are subject to income tax however, if this occurs before age 59 ½ for the reasons listed below, you get to call mulligan.  

  • Qualified Higher Education Expenses 

As an option, you can withdraw funds to cover expenses related to qualified higher education. These expenses include tuition, fees, books and supplies, and can be used for yourself or your immediate family members. In addition, distributions are permitted to cover room and board for students enrolled more than half the time. This withdrawal type has no set dollar limit. 

  • Health Insurance Premiums 

If you are currently unemployed, you may be able to use funds from your IRA to pay for health insurance premiums for yourself, your spouse, and your dependents. There is no limit to the amount you can withdraw for this purpose, but certain conditions must be met to avoid a 10% penalty. These include collecting unemployment compensation for 12 consecutive weeks and making the distribution within the year you received the payment or the following year. Additionally, the distribution must occur 60 days after you gain employment. 

  • Unreimbursed Medical Expenses 

If you have unreimbursed medical expenses, an IRA Distribution can be used to cover them. The expenses must exceed 7.5% of your AGI. Subtract any insurance reimbursements you have received to calculate your medical expenses. Distribution for the amount that is above 7.5% of your AGI is penalty-free. 

Example: Assuming your AGI is $120,000 and your family’s medical expenses for the year are $16,000, with an insurance reimbursement of $6,000, the remaining unreimbursed amount is $11,000. Since 7.5% of your AGI is equal to $9,000, and your expenses exceed that amount by $2,000, you can only use $2,000 of your IRA assets to cover the medical costs. 

  • Substantially Equal Periodic Payments (SEPPs) 

This distribution type is quite complex and operates like an annuity program. It is beneficial for IRA owners who require distributions over several years. Choosing a SEPP is a long-term commitment and is not suitable for immediate cash needs. With a SEPP, you can receive annual distributions for a specified period using a selected calculation method, which can be a fixed payment or vary from year to year. The conditions of a SEPP are as follows: 

  • If you decide to begin a SEPP, you must continue for five years or until you reach the age of 59 1/2, whichever comes later. If you opt to end the payments, you must pay the previously avoided penalties. 
  • Once you start the program, you cannot contribute to your IRA or receive any other distributions aside from your yearly payout. 

This program benefits most IRA owners in their 50s who need an influx of annual income before age 59 ½ while avoiding the 10% penalty. 

  • First-time Home Purchase 

You can withdraw $10,000 for an individual and up to $20,000 for couples to put toward purchasing a first home. This type of withdrawal qualifies for the exception under the following circumstances: 

  • You have not owned a home in the preceding two years. 
  • In the event of a delay in the purchase or construction of your home, it is important to return the funds to your IRA within 120 days to avoid any penalties. 

This distribution can be used to help purchase a first home for a child, grandchild or parents. 

  • Qualified Reservist Distributions 

This withdrawal type is strictly for members of the military reserves. If you take a distribution during active duty, you qualify for an exception to the 10% penalty. The two conditions for this exception are: 

  • This order or call to duty must have occurred after Sept. 11, 2001 
  • For a period of more than 179 days 

This distribution may be available to reservists of the Air Force, Army, Air National Guard, Army National Guard, Coast Guard, Marine Corps, Navy and Corps of public health Service. 

  • Birth or Adoption of a Child 

As a new parent, you may withdraw up to $5,000 from your IRA without penalty to provide financial support for your newborn or adopted child within one year of their birth or adoption. In case of any financial changes, you have the option to put the funds back into the IRA so that they can continue to grow for your retirement. 

  • Qualified Charitable Distributions (QCD) 

QCDs are the best shot of all; this is a hole-in-one. If you are an IRA owner over 70 ½, you can choose to have your charitable donations paid directly from your IRA to the charitable organization. This is a tax-efficient way to fulfill your philanthropic wishes, as the distribution is entirely tax-free. The conditions of a QCD are: 

  • QCD must not exceed $100,000 each year. This is not a household combined amount; your spouse could contribute $100,000 as well. 
  • The funds must be taken directly out of your IRA by Dec. 31. 
  • The donation must be sent directly to a qualified charity. 

Required Minimum Distributions (RMDs) 

RMDs were introduced to ensure you have taxable income within your lifetime. Consider an RMD to be a handicap. Your handicap approximates what you will shoot or, in this case, the amount you will have to withdraw in the current year. Once you turn 73, you must start taking an RMD. You can postpone the first RMD until April 1 of the following year, but it’s important to note that you still need to take the initial RMD by April 1. This will be an annual requirement, with the RMD due by Dec. 31 every year. Your handicap is often recalculated, and your RMD is based on your account value on Dec. 31 of the previous year.  

To excel in golf, the objective is to play the game with the least number of strokes possible. Similarly, the goal of a traditional IRA is to ensure minimal distribution and maximum accumulation. However, if you are required to take a distribution, remember to call for a mulligan when needed, aim for a hole-in-one if you desire and always calculate your handicap to stay on top of your game. Contact an Adams Brown wealth management advisor to help you make the best decisions to get you to your retirement goals.