The Basics

Your Individual Retirement Account (IRA) is a savings account where you keep stocks, bonds, mutual funds, and other assets. There are several types of IRAs: Traditional IRA, Rollover IRA, Simple IRA, SEP-IRA, and Roth IRA. When you opened your IRA, you received great tax benefits and invested in your future: a secure, enjoyable retirement. While you will ideally wait until you’re at least 59 ½ years old to withdraw from your IRA, there may be situations where you need to withdraw early. That said, a penalty may apply.

The Penalty

If you withdraw early from your IRA before you’re 59 ½, you may have to pay a 10 percent tax penalty. Congress put this penalty in place to encourage individuals to save their investment capital for the future, rather than spending it on short-term problems. The good news is that there are exceptions to this rule if you must make an early withdrawal from your IRA.

The Exceptions

That 10 percent tax penalty sounds scary, but it doesn’t have to be. You might even avoid that fee for early withdrawal from your IRA if you’re:

1. Buying a Home for the First Time

If you’re a qualified, first-time homebuyer, that 10 percent tax penalty is waived on up to $10,000 of IRA withdrawals. You can use these funds to buy, build, or remodel a first home for yourself, your spouse, a child or grandchild, or a parent or grandparent. You can see if you meet the IRS definition of a first-time home buyer here.

2. Covering Higher Education Costs

If you’re paying for yourself, your spouse, your kids, or your grandchildren to receive higher education, that money doesn’t grow on trees. But, it has been growing in your retirement account, and an early withdrawal from your IRA will not be penalized if you’re doing so to fund schooling. You can thank the Higher Education Act of 1965 for this exception that allows IRA distributions to cover certain expenses for colleges, universities, and vocational schools.

3. Suddenly and Permanently Disabled

If you become permanently disabled—either physically or mentally—and are no longer capable of working to support yourself, you may make a penalty-free early withdrawal from your IRA. Your doctor must certify that you’re no longer able to work and that your disability will either last a significant amount of time or eventually lead to your death. And, if you do unfortunately pass away before age 59 ½, your beneficiaries can inherit your retirement funds without penalty.

4. Inheriting IRA Assets

If you’re the beneficiary of a parent, grandparent, or other non-spouse who has passed away, you won’t have to pay the tax penalty for early withdrawal from your benefactor’s IRA. There are a few more technicalities when it comes to inheriting an IRA from your deceased spouse. If you treat your inherited IRA as your own, then any amount you withdraw will be subject to the tax penalty. However, if you title this as an “Inherited IRA,” then you will have to pay the 10 percent tax penalty.

5. Going into Active Duty

If you are a military reserve who is called to active duty, you will not be subject to the tax penalty for early withdrawal from your IRA. In this case, your withdrawal is a “qualified reservist distribution” when you meet the following requirements:

• You were called to active duty before September 11, 2001;
• You were called to active duty for a period longer than 179 days, or for an indefinite period of time; and
• The distribution was made after the date you were called to active duty and before the period of active duty ended.

6. Paying Your Medical Insurance Premium

If you lose your job or suddenly must pay your own medical insurance premiums, you can make an early withdrawal from your IRA without paying the tax penalty. Keep in mind that this exception only applies if you’ve been on unemployment for more than 12 weeks. Also, if you become re-employed, you cannot receive your withdrawal more than 60 days after your new employment begins.

7. Paying for Steep Medical Expenses

If you or your children are seriously ill or injured, those medical costs can add up quickly. If they exceed 10 percent of your adjusted gross income, you can make an early withdrawal from your IRA without paying the tax penalty. If you qualify for this exception, make sure that you pay your medical expenses the same calendar year that you are withdrawing those IRA funds.

These exceptions can be confusing, and they might differ depending on which type of IRA you have. That’s why it’s smart to consult with a qualified financial advisor who has your best interests in mind. This will help you understand the ins and outs of early withdrawal from your IRA, giving you peace of mind and security about your financial decisions.

Lorenz Financial Services, LLC is a Lafayette, Indiana fiduciary who offers financial planning and portfolio management services. If you have questions about who we are or our services, please contact us at (765) 532-3295 or email us.

The post What You Need to Know About Early Withdrawal from Your IRA appeared first on Lorenz Financial Services | Lafayette Indiana.

1. Spend less than you make.

Spending less money than you bring in is the golden rule when it comes to saving money and reducing debt. Whether you are 10 years into retirement or a young, working professional, these are words to live by.

2. Join your employer’s retirement plan.

In order to manage debt, you’ll need to start paying it off. This includes credit card debt, personal loans, 401K loans, payday loans, and any other unsecured debt.

Unsecured debt is debt that is not backed by an asset and the interest rate is not tax deductible. Unsecured debt is often referred to as “bad debt” because the interest rate is high and should be paid off as soon as possible.

3. Pay off “bad” debt.

In order to manage debt, you’ll need to start paying it off. This includes credit card debt, personal loans, 401K loans, payday loans, and any other unsecured debt.

Unsecured debt is debt that is not backed by an asset and the interest rate is not tax deductible. Unsecured debt is often referred to as “bad debt” because the interest rate is high and should be paid off as soon as possible.

4. Build an emergency fund.

Having an emergency fund is very important. The money in your emergency fund should be liquid, as in easily accessible, and should be enough to live on for three to six months.

Having an emergency fund is a proactive way to manage debt because you can prevent the need to take out loans to pay for things in emergency situations, such as a medical bills after an accident or losing your job.

5. Start an IRA.

Start an IRA for both you and your spouse. It’s best to begin with a deductible IRA; however, if you have a retirement plan at work, you are not eligible for a deductible IRA. In this case, you should opt to start contributing to a Roth IRA.

Increase your IRA contributions by half of your annual pay raises until your IRAs are maxed out for both you and your spouse. After you turn 50, plan to contribute to the “catch up” provision for you and your spouse as well. Make sure to save ahead of time so you are able to purchase your IRAs on January 2 of each year.

If you have questions about this, don’t fear. A financial advisor can help you determine how an IRA can best work for you.

6. Purchase insurance.

Life is unpredictable and because of that, it’s important to have insurance. Purchase the appropriate insurance that is not provided by your employer. This can include medical, homeowners or renters, term life, umbrella liability, auto, and disability income insurance. At age 55, you should invest in long-term care insurance.

7. Pay off student loans.

Student loans are considered “good debt” because they have low interest rates. However, do not let this fool you; student loans are dangerous to have because even if you declare bankruptcy, your student loans will not disappear. Therefore, it is best to pay them off as soon as possible.

8. Put away money for your next home.

To avoid paying private mortgage insurance when you purchase your next home, start putting away enough money to make a 20% down payment on your next home.

Mortgage debt is considered reasonable debt because the interest rate is relatively low. If a 30-year mortgage will allow you to save more money or reduce bad debt, stick with a 30-year mortgage as opposed to a 15-year mortgage. Take out a fixed rate mortgage when mortgage interest rates are low and take out a variable rate mortgage when interest rates are high.

9. Save for your next car.

A car loan has a low interest rate because the loan is secured. That being said, we don’t recommend getting a car loan that will last more than 36 months. If you will need a longer-term loan to afford the car you want, it would be best to save more for the down payment or opt for a more affordable vehicle.

It is also important to pay off each car loan before buying another car. If you and your spouse both need a car, it’s wise to purchase a new car every five years, keeping in mind that each car will last about 10 years.

10. Start building your child’s college fund. 

The price of a college education is only getting more expensive. That said, saving for your child’s college should be your last financial objective. While you can borrow money to pay for college, you can’t borrow money to pay for your retirement.

11. Pay off your mortgage before you retire.

After you retire, you will have a reduced or limited income. Your mortgage is a huge monthly expense, and you will thank yourself later for paying it off earlier rather than later.  

12. Delay taking Social Security.

The key here is while it is best to delay taking Social Security for as long as possible, you should absolutely take it when you need it. If you’re still working but of retirement age, the income taxes on your Social Security income will be very high. Additionally, every year Social Security is delayed beyond age 62, future payments will increase between 6.5% and 8.3% per year. This rule extends until you reach your maximum eligible payment at age 70 and means that you are guaranteed a monthly Social Security income of 76% more than what could have been received at age 62.

It goes without saying that you should be saving and you should be paying off your debt. Following a calculated plan to save money and manage debt is the best way to ensure you and your finances are prepared for things life may throw your way. These 12 steps are a great place to start planning for your future.

Lorenz Financial Services, LLC is a Lafayette, Indiana fiduciary who offers financial planning and portfolio management services. If you have questions about who we are or our services, please contact us at (765) 532-3295 or email us.

The post A 12-Step Savings and Debt Reduction Plan appeared first on Lorenz Financial Services | Lafayette Indiana.