How to Tap IRA Without Penalty
Q. I am 55 and have fallen on hard times. I would like to tap some of my tax-deferred retirement savings plans. I have an individual retirement account, a 401(k) account and a 403(b) account. The IRA was opened when I lived in another state. Which account should I hit first? Do I have to pay taxes based on my tax rate at the time I made the contributions or at my current tax rate? Do I have to pay state taxes to the state I resided in when I made the contribution, or just to California, where I currently reside? Is the penalty assessed on the full amount of the withdrawal or the amount I receive after the taxes are paid? --T.R.B .
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A. If ease and speed are primary considerations, tapping your IRA may be your best first stop because you will not need to consult anyone or get permission before making a withdrawal. Furthermore, you may even be able to withdraw funds from your IRA without paying the 10% federal and 2.5% California penalty imposed on withdrawals made prior to age 59 1/2.
The penalty is avoided when the taxpayer under age 59 1/2 sets the annual withdrawal amount according to a life expectancy table for a person his or her age. Payments at this annuity-schedule rate must continue for a minimum of five years or until you reach age 59 1/2, whichever is longer. You may not change the amount you receive from your IRA until this period is complete; if you do change it, the IRS will impose the early-withdrawal penalty on all the taxable payments received up to this point, plus interest charges.
Making an early withdrawal from a 401(k) or 403(b) account may be more difficult; it will depend on the individual rules of the plans in which you hold accounts. Most plans make provision for hardship withdrawals before age 59 1/2. Check with your plan administrator. You may also be able to get a loan against your 401(k) or 403(b) fund balance. Early-withdrawal penalties are not assessed on these loans.
However, be warned that many plans do not permit loans, and securing one is usually a slow process. Loan proceeds are not subject to income taxes, and if you use your loan proceeds for your general living expenses, your interest charges would not be deductible.
Any withdrawals from your IRA or other tax-deferred retirement savings plan are subject to ordinary income taxes at the rate in effect for you at the time the withdrawals are made--not the rate in effect when the contribution was made.
(Be careful: The amount you withdraw from your retirement account is included in your gross income for the year, which may bump up your marginal tax rate.)
State taxes and any applicable penalties are paid to the state in which you reside at the time the withdrawals are made, not the state in which you resided when you made the contributions. Any penalties are assessed on the amount withdrawn before taxes are assessed, not the amount you actually get after taxes are paid.
Check Employer Before Transferring Annuity
Q. I hold a variable-rate annuity through a 457 account my employer offers. I am not satisfied with the returns this investment is generating. May I transfer my funds to another annuity without losing the tax advantages the account offers? --B.M .
A. Because 457 accounts (tax-deferred compensation plans for government agencies and nonprofit organizations) are funded entirely by employers, employers have complete control over their handling. Employees generally do not have any discretion over how the funds are invested. To be completely sure about how your plan is handled, check with your plan administrator.
Clarifying Whose Account Is Whose
Q. I recently added my name to my elderly mother’s bank accounts to help her handle her financial affairs. Her income is so low that she does not even have to file a tax return. How do I ensure that the government understands that the interest earned on her accounts is really used by her and that I receive nothing from her accounts?-- P.J.O .
A. Your mother’s Social Security number should be the one the banks lists as the principal account holder. (You may not even have known this if the account was opened before your name was added.)
If you are still worried that the IRS won’t be satisfied, you can ask the banks to draft a statement detailing when the account was originally opened and showing that you have only recently been added to those accounts as a matter of convenience to her. Better yet, ask your mother to draft such a statement and sign and date it. The odds are you won’t need all this, but if it makes you feel more secure, it’s worth the effort.
Ginnie Maes Subject to State, Federal Taxes
