IRA Timing is Critical: An Advisor’s Guide to Key Ages, Dates and Years

Pop quiz… What do comedy routines and IRA planning have in common? Give up? The answer is “timing is everything!” Unfortunately though, the tax code isn’t exactly friendly when it comes to timing issues. Advisors must be aware of all sorts of different dates, ages and “clocks.”

Age 59 ½ Exception to the 10% Early Distribution Penalty

In general, IRA owners must wait until they are 59 ½ to withdraw IRA funds without a penalty. The age 59 ½ rule is based on a client’s actual age. A person is considered to be 59 ½ on the same numbered day of the month (when possible) six months after they turn 59. For instance, someone born on March 5th will turn 59 ½ on September 5th, regardless of the actual number of days between the two dates.

Age 55 Exception to the 10% Early Distribution Penalty (Plans Only) 

Unlike the age 59 ½ exception to the 10% penalty, the age 55 exception applies to distributions from company plans when the plan participant separates from service in the year they turn 55 or older. For the purpose of this rule, the applicable year is a calendar year and not 365 days.  Remember though; the age 55 exception only applies to distributions made from plans and NOT from IRAs (including SEP and SIMPLE IRAS.

Age 70 ½ Rule for IRA RMDs

Required minimum distributions (RMDs) must begin for the calendar year in which an individual turns 70 ½. This is true even if the IRA owner is still working, as there is no “still working” exception for IRAs, including SEP and SIMPLE IRAs. What makes this rule a little tricky is that even though distributions must begin for a specific calendar year, it’s possible for a client to take their first distribution in either of two calendar years to satisfy the requirement. That’s sounds a little crazy, but here’s how it works…

A distribution taken in the calendar year in which a client turns 70 ½ will count towards fulfilling the client’s first RMD requirement, even if the client is not yet 70 ½. However, a special rule allows clients to defer taking their first RMD until April 1st of the calendar year after the year in which they turn 70 ½. This is known as the required beginning date (RBD). A distribution taken in the calendar year after a client turns 70 ½, but by no later than April 1st, will still satisfy the first year’s RMD requirement without triggering any penalties.

Age 70 ½ Rule for QCDs

Qualified charitable distributions (QCDs) are direct transfers to charitable organizations from an individual’s IRA or inherited IRA. Using this provision, eligible clients are able to exclude the amount transferred, up to $100,000, from AGI. The transfer can also be used to help satisfy a client’s RMD.

As of this writing, QCDs are not currently in effect, but each time it’s expired in the past, it has been brought back (sometimes retroactively) with the same age 70 ½ rule.

Under this rule, the only individuals able to make QCDs are IRA owners and IRA beneficiaries who are actually age 70 ½ or older at the time the QCD is made. Direct transfers to charity made in the year an IRA owner or IRA beneficiary turns 70 ½, but before the individual actually turns 70 ½, do not qualify for QCD status. Instead, the income from the distribution must be added to AGI and a charitable deduction may be taken as an itemized deduction.

5-Year Rule for Roth IRA Conversions

When it comes to the taxation of Roth IRA distributions, many advisors and clients struggle to figure out just what is taxable and/or subject to a penalty. And given the fact that there are actually two separate Roth IRA five-year rules, it’s not too difficult to understand why. One five-year rule applies only to Roth IRA conversions. Under this five-year rule, penalty-free distributions of Roth conversions may be made at the client’s actual attainment of age 59 ½ OR after five full years, whichever is sooner. A separate five-year period is established for each of a client’s conversions.

The wrinkle that throws many advisors off is that the five-year clock begins to tick on January 1st of the year the funds are deposited in the Roth IRA. As a result, even though a separate five-year period applies to each Roth conversion, multiple conversions made in the same calendar year have a common clock.

5-Year Rule for Roth IRA Qualified Distributions

Roth IRA qualified distributions are the name of the game. In a qualified distribution, every dollar that comes out of the Roth IRA is tax-free and penalty-free. Qualified distribution are distributions made five full years after a client establishes their first Roth IRA AND the client’s attainment of age 59 ½, their death, disability or the first-time purchase of a home ($10,000 lifetime cap).

Here again, attainment of age 59 ½ is the client’s actual age 59 ½, but the client must also complete the five-year requirement. Remember, this five-year rule is a different five-year rule than the rule for conversions. One difference is that the five-year clock for qualified distributions can, in some cases, begin to tick on January 1st of the year before the first dollars are actually contributed to a Roth IRA.

How? A contribution to a Roth IRA will start the Roth qualified distribution clock ticking on January 1st of the year the contribution is made for, which is not necessarily the year the contribution is made in (since Roth contributions can be made up until April 15th of the year after the calendar year it is being made for). Another important point is that the five-year rule for qualified distributions is common for all Roth IRAs (separate clocks are not needed).

5-Year Rule for 72(t) Payments

72(t) payments, also known as SEPPs or SOSEPPs (a series of substantially equal periodic payments), are distributions from an IRA that allow the owner to access money penalty free. 72(t) schedules can be doubly confusing since there are two separate timeframes to keep track of. In order to successfully “complete” a 72(t) payment schedule and avoid back penalties and interest, the schedule must continue for the longer of five years or until a client reaches 59 ½.

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Jeffrey Levine, CPA

About Jeffrey Levine, CPA

Jeffrey Levine, CPA is an IRA Technical Consultant with Ed Slott and Company, LLC. He is a contributing writer and editor for Ed Slott's IRA Advisor newsletter and has been quoted in numerous publications, from the New York Times to the San Francisco Chronicle. A frequent presenter of advanced training programs, Jeffrey has educated thousands of Financial Advisors and consumers on IRA tax and estate planning strategies. Visit Ed Slott and Company's website at irahelp.com or Email Jeffrey at Jeff@irahelp.com. You can follow Jeffrey on twitter @iraguru4edslott.