For the Young-uns
If you've got more than, say, 20 years until you're planning to retire, at about this point in the lesson you're probably thinking that it is waaaay too early to concern yourself with tax issues. Maybe and maybe not. This is important stuff to know, as it can have a major effect on the amount of moolah you'll have when you'll retire.
If you find questions popping up as we proceed, here are a few Tax FAQs that may have some information you crave:
IRA Conversions that Benefit You
How Many Roth IRAs Do You Need?
IRA Withdrawal (Penalty-Free) for Homebuyers
Now, back to our regular programming...
Periodic Payment Exception
Regarding your employer retirement plan and your other retirement accounts (such as IRAs), you can take distributions before age 59½ as long as you take the funds in the form of a series of "substantially equal periodic payments" (SEPP). If you're dealing with your employer's defined contribution plan, the type of SEPP (see below) may be specified by that plan, which means you will have no choice on how the SEPP are computed. That's something you will need to talk over with your benefits administrator should you decide to take money from your company plan using SEPP. On the other hand, you may have a pension plan. In that case, any annuity you elect at retirement is automatically exempt from an early withdrawal penalty because it's paid over your estimated life expectancy at retirement.
But for many, wealth is tied up in IRA accounts, especially if you rolled over your current or prior company plans into an IRA. In order to stay within the penalty avoidance rules, you need to understand how they work. We provide the details to Getting the Money Early in our Retirement area at Fool.com. Basically, you have three choices in taking your penalty free distributions:
Option No. 1: The Life Expectancy Method
The life expectancy for the participant or the joint life expectancies for the participant and a beneficiary are determined using the IRS life expectancy tables found in the IRS Publication 590, Individual Retirement Arrangements. (You need Adobe Acrobat to read this document.) The account balance as of the beginning of the year is divided by the life expectancy factor found in the applicable table. If your account balance is $100,000 and the table states that you are expected to live 20 years, you can take $5,000.
Option No. 2: The Amortization Method
In this method, life expectancy is again determined using the tables in IRS Publication 590. Additionally, an assumed earnings rate may be used to determine the annual withdrawal amount that will deplete the entire account over that life expectancy. The rate must be a "reasonable interest rate" decided on before the withdrawals begin, and generally it must be within 80% to 120% of the applicable federal long-term rate.
Option No. 3: The Annuity Factor Method
This method results in a fixed withdrawal amount like the amortization method, and it is computed similarly. The difference is in the fact that IRS life expectancy tables are not used. Instead, those in general use by the life insurance industry are acceptable. An annuity factor derived by using the UP-1984 Mortality Table is the standard for this method. The resulting calculation results in the highest withdrawal amount of the three approved withdrawal methods.
Your choice of one of these three methods will depend on your current age and your need for income from your IRA. So you'll want to make sure that you have all of the facts and are comfortable with the computations prior to making your decision. This is one area that requires particularly close planning.
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