MAKING EARLY IRA WITHDRAWALS WITHOUT PENALTY
Normally, withdrawals before age 59 1/2 from an individual retirement account
(IRA) or a qualified retirement plan such as a 401(k) or pension plan are subject
to not only income taxes, but a 10% penalty. For example, a taxpayer aged 54
who withdraws $10,000 from an IRA might pay a total of $3,800 in taxes and
penalties ($2,800 in taxes assuming a 28% tax bracket and a $1,000 premature
withdrawal penalty). But there are important exceptions to this rule that can
eliminate the penalty (but not the taxes).
The first two exceptions are ones that most people would just as soon not
experience: total and permanent disability and death (at which point the IRA or
qualified plan balance is distributed to your beneficiary or estate). A third
exception applies if you turn 55 in the calendar year you retire from your
company; you can make withdrawals from the company-sponsored retirement
plan (but not an IRA) without penalty.
A fourth exception allows you to withdraw early even from an IRA, which can be
beneficial for those who need or want the money early because they've lost their
job, have chosen to retire early, or simply need cash. This last exception is done
by taking what the tax law calls substantially equal periodic payments (made at
least annually), or more simply, level payments. This allows you to take out cash
but leave the bulk of your funds in the account to continue to grow tax deferred.
The IRS allows you to choose one of the three methods to determine how large
those payments will be.
Life Expectancy. Divide the total amount in the account by your life expectancy or
the combined life expectancies of you and the account's beneficiary according to
IRS tables (Publication 590). Usually this provides the smallest periodic payment.
Amortization. You amortize the payments by choosing a "reasonable" interest
rate. "Reasonable" is open to interpretation. Choose one too high or too low and
the IRS might dispute the rate. Picking something close to pri