Transfers and Withdrawals from an IRA: Today's Slott Report Mailbag
By Jeremy T. Rodriguez, JD
Follow Us on Twitter: @theslottreport
I have a friend, 45 years old, who has both an individual Roth IRA and an individual rollover IRA. The Roth is over 5 years old. He would like to know if he can use either to pay off a debt he incurred several years ago. He is aware that a straight withdrawal from the individual IRA will be treated as ordinary income and be subject to a 10% penalty. Is the same true for a withdrawal from the Roth? Can the withdrawals be structured as a loan and if so how does he structure the re-payments to satisfy IRS scrutiny and regulations.
You and your friend are correct; if he takes a withdrawal from a Traditional IRA it will be taxed as ordinary income. Additionally, since he’s under age 59 ½ he would be subject to the 10% early withdrawal penalty unless another exception applies. When it comes to Roth IRAs, the rules are a little different. While IRAs (both Traditional and Roth) cannot offer loans, his Roth IRA contributions can be withdrawn at any time, tax and penalty free. Converted amounts can also be withdrawn tax free, but the 10% penalty rules would apply if a conversion occurred less than five years ago.
The earnings in that Roth account, however, could be subject to taxes or penalties. Given your friend’s age, if the account is truly 5 years old (measured from the first of the year in which you first established and contributed to the Roth), taxes and penalties on the earnings will not apply if the distribution is due to his disability or being used to purchase or build a first-time residence. If not, then taxes and the 10% penalty will apply to the earnings. The 10% penalty could be waived if he meets one of the exceptions listed in IRS Publication 590.
Finally, he could look into a 72(t) payment schedule. This is a series of substantially equal periodic payments from an IRA or retirement plan that does generate income tax but avoids the 10% penalty. However, be advised that the permissible payments might not meet his financial needs and there are heavy penalties for non-compliance. Given his age, he would be looking at having to comply with the 72(t) rules for 14 years.
We transfer a taxable 401(k) into a regular IRA. No problem, so far.
We now want to transfer part of that IRA into an annuity.
Questions ... (1) How many times can a regular IRA (not ROTH) be transferred in a 12 month period? (2) Can we transfer a 401(k) into an IRA account at a stock broker and then transfer part of that IRA into an annuity within a 12 month period ... with no income tax consequences?
Thank you for considering the question, John.
Transfers are not the same as rollovers. A transfer is when the retirement funds go directly from one account to another. You cannot use the funds when doing a transfer. You can do as many transfers as you want at any time. For IRAs, a rollover is when a check is made payable to the IRA owner. The owner then has 60 days to redeposit the funds into another retirement account.
There is a rule in the tax code that limits 60-day rollovers from an IRA (both Traditional and Roth) to once per year. The rule is applied on an individual basis, and not an account basis. However, there are several exceptions to that rule. First, it only applies to 60-day rollovers, not direct transfers. Second, it does not apply to any transactions between an IRA and a company retirement plan (such as a 401(k)). Therefore, your transaction with the 401(k) plan did not count against that rule.
With respect to the annuity, if you are looking to open an IRA annuity, or simply hold an annuity within an IRA account, you can do so without triggering taxes or penalties. Holding an annuity within an IRA is no different than investing in stocks or bonds. For the IRA annuity, you would just want to directly transfer the rolled over 401(k) funds into the new IRA annuity. The direct transfer wouldn’t cause any taxes or penalties.
Finally, be aware that one of the biggest benefits of an annuity is tax-deferred growth – something you are already getting with an IRA or company retirement plan. Thus, you need to understand all of the fees, riders, and liquidity restrictions that come with an annuity before making that investment.