In
today's world, there are times when your investment plans go
awry and you have to make adjustments to meet current needs. Naturally, you would like to
keep your retirement savings intact. But the fact is that today's bills could
easily become a higher priority. The question now becomes "what should you do?"
Cashing-in the funds you have accumulated in your Individual Retirement Account (IRA) or your employer's retirement plan
is one option, but
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if you are under the age of 59 ½, this approach could incur a 10 percent
premature withdrawal penalty, in addition to current income taxes on the taxable portion
of the distribution amount.
If the distributions came from your employer's sponsored retirement plan,
the employer would be required to withhold 20 percent for your federal income tax liability.
After all that, you may even find yourself in a higher tax bracket due to the distribution.
Cashing in the funds in your retirement account is probably not the best approach. There is a better way. An alternative exists that can help maintain the delicate balance between your present cash flow and your future security. This approach is known as a
72(t) distribution. The name comes from section 72(t)
of the Internal Revenue Code. This section of the code details the conditions under which a series of premature distributions can be make from an
IRA or another specified retirement plan without incurring the usual 10 percent tax penalty. This can potentially provide an additional 10 percent of income, either now or at some point in the future.
To qualify for 72(t)'s waiver of the early withdrawal tax penalty, a
premature distribution must be structured according to specific rules. Here are some of the basics of which to be aware.
First, once 72(t) distributions start, they must continue for at least five years or until you reach 59 ½, whichever period is longer. When the longer period is over, you are free to change the amount of the payments or stop receiving them altogether.
Second, the IRS has outlined three methods of calculating the amount of a
72(t) payment. These are life expectancy, the amortization, and the amortization methods. While all three are based on the account owner's life expectancy (or joint life expectancy of the owner and the beneficiary), each produces a different figure. Your financial advisor
can show you the distribution differences between the three schedules and determine which schedule is best in your situation.
Lastly, although any IRA owner may take a
72(t) distribution at any time, for any reason, these distributions may make
more sense for people with fairly large account balances. Since the calculation of payment amounts factor in life expectancy as well as the size of the account balance, smaller accounts yield relatively small payments. Similarly, younger account owners will tend to have smaller payouts because they are likely to live longer.
If you feel a 72(t) distribution might be something you
could take advantage of, you will want to work closely with your financial advisor. He or she can make sure the distribution program meets your cash flow and retirement savings objectives.
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