TIRA withdrawl- 10% penalty/replacement/timeframe
My client is dealing with a shortage in cash and working on finding the least of their “painful” alternatives.
In 2009, (next few days) the client (age 56,57) is planning on withdrawing roughly $40,000 (to cover estimated future family expenses) from their Traditional IRA’s due to 7 months of unemployment.
Because of their low income and deductions-medical/job search/costs for 2 children in college (spent and exhausted emergency funds), they’re in the estimated 0% tax bracket for 2009 (based on Turbo Tax 2009).
The client would like to withdraw up to the maximum of their marginal 0% tax bracket or possibly up to 15%.
1. Is the 10% tax penalty for IRA withdrawls before 59 1/2 waived due to unemployment? (Does recieve unemployment compensation)
2. If he gets a job in 2010 and wants to replace the $40,000 previously in his TIRA, can he set up a new Roth (because it was included as income in 2009 tax return) and consider it a repayment of his prior years contributions? (so he can still also do 401k and $6,000 IRA for 2010).
3. Is there a timeframe in which the $40,000 must be replaced to still be characterized as a taxed prior years contribution? (for example-if he gets new job, does he have all of 2010 to replace funds?)
Thank you for your thoughts and your time,
Sincerely, Heidi Davis
Permalink Submitted by mk foss on Tue, 2009-12-29 18:58
I’m sorry to hear about your clients’ difficulties.
1. There is no exception from the 10% penalty for unemployment per se. There is an exception for funds withdrawn to pay medical insurance premiums while unemployed. There is also an exception for funds withdrawn for higher education. To take advantage of these exceptions they must show that they spent as much money in the year as the amounts withdrawn – any excess withdrawal would be subject to the 10% penalty. There are other conditions on what the higher education funds are spent for.
2. You cannot replace TIRA withdrawal funds by putting the money into a Roth at a later date. There is a 60-day window to replace TIRA funds or to complete a Roth conversion. So, if he gets a job within 60 days of the TIRA withdrawal, he can replace the 40k by going to a new Roth or the old TIRA.
3. The replacement time limit is 60 days. If he has a number of IRAs he can stretch that period. For instance if he withdraws $40k from IRA-1, on the 55th day or so, he could withdraw $40k from IRA-2 and then have 60 days to repay that one. You wouldn’t recommend this strategy unless someone is desperate. In order for it to work, you need a number of IRAs. He could or she could split their IRAs into multiple accounts to take advantage of this scheme.
Good luck
Permalink Submitted by Alan Spross on Tue, 2009-12-29 19:08
1) No waiver just for unemployment, but there is a waiver for medical INSURANCE premiums paid IF at least 12 consective weeks of UC were collected. The medical costs must be paid in the same calendar year as the IRA distribution, so some immediate number crunching is required to determine how much of an IRA distribution should be taken prior to year end vrs how much to take in 2010. Note that there is also a different waiver for medical costs paid including insurance, but there is no double dipping on the insurance portion if client qualifies for both exceptions. The medical costs do NOT require collecting UC. (See pages 53 and 54 of Pub 590 for more details).
2) The distribution dates above are further complicated if there is a rollover possibility. There is a limit of one rollover per 12 month period, so if an IRA distribution is taken now and another one later, only ONE of them can be rolled back if that opportunity exists. One way to get around the one rollover limit is to do a Roth conversion within 60 days of the distribution, and then recharacterize the conversion back to the TIRA. Conversions and recharacterizations do NOT count against the one rollover limit. The Roth conversion (or rollover back to TIRA) must be completed within 60 days of receipt of the IRA distribution. 401k for 2010 can be done from any new employer in 2010; regular IRA contribution depends on income limits if it is to be deducted, or if it is a Roth contribution.
3) 60 day limit per above. For example, if distribution is taken out tomorrow it must be reported on 2009 return, but if it is rolled back or converted to a Roth IRA within 60 days, that is also reported on the 2009 return. If they convert, should be able to pay the taxes out of non IRA assets.
With two days to go, this appears to require some tough number crunching because of the combined penalty waiver and rollover options being considered.
Permalink Submitted by Heidi Davis on Wed, 2009-12-30 03:58
Alan and Mary Kay-
Thank you for your time and ideas.
That is very helpful!!!!
I appreciate your time in working to help this family.
Their portion of college expenses was more than $40,000 in 2009- tuition alone-2 daughters, 2 private schools.
On the number crunching that needs to be done–yes, I agree, it’s a lot for a short period.
I’ve got estimates in Turbo Tax 09 and Excel ready to go so I can check out this alternative for them.
Heidi