Hatching a Bigger Nest Egg – Part I

Why it pays to plan IRA distributions

IRAs are an important tool you may use to grow a sizable nest egg for a comfortable retirement because they offer tax-deferred — and even tax-free — growth. Over time, these benefits are more apparent when you see the effect of compound growth on your earnings.

But when it comes to maximizing an IRA’s advantages and minimizing taxes, timing is everything. Although you can take IRA distributions at any age, you may face unnecessary taxes or penalties if you take them at the wrong time — or don’t take them at the right time. Thus, you need to know the earliest (or latest) possible time you may take distributions so you have enough income to support you and your spouse during your golden years.

Know the Differences between a Traditional and a Roth IRA

Although Traditional and Roth IRAs both offer tax-saving benefits for retirement, each treats contributions and distributions quite differently. For instance, you may be able to deduct Traditional IRA contributions depending on your income level and eligibility. If you contribute to an employer-sponsored retirement plan, the adjusted gross income (AGI) phaseout range for 2007 is $52,000 to $62,000 if you are single and $83,000 to $93,000 if you are married filing jointly and both spouses participate in an employer-sponsored plan. If only one spouse participates, the phaseout for that spouse’s eligibility is $156,000 to $166,000. (There are no income limits if you don’t participate in an employer-sponsored retirement plan.) The distributions are subject to your ordinary income tax rate at the time you receive them.

Conversely, you cannot deduct Roth IRA contributions, but qualified distributions are tax-free. But like a Traditional IRA, your income may limit your eligibility to make contributions. For instance, Roth modified AGI limits for 2007 are $99,000 to $114,000 for singles, $156,000 to $166,000 for married couples filing jointly and up to $10,000 for married couples filing separately, regardless of whether you participate in an employer-sponsored retirement plan.

Take Money Out At Your Own Risk: Early Distribution Penalties

Age 59 ½ typically is the earliest time you may receive unlimited Traditional or Roth IRA distributions penalty-free. But, there are instances when you may take early distributions and avoid penalties, such as when you:

• Take regular distributions in virtually equal amounts over your life,
• Buy or build a first home — up to $10,000,
• Pay qualified higher education expenses,
• Receive reimbursement of excess medical costs,
• Become disabled, or
• Are unemployed and pay medical insurance premiums.

Roth IRA holders also may withdraw funds penalty-free in other circumstances as early as five years after their first account contributions. The IRS treats distributions first as nontaxable returns of contributions, so you will not owe tax on distributions that don’t exceed contributions. But you will be subject to regular income tax and a 10% penalty on amounts that exceed accumulated contributions.

What You Have to Do - Minimum Distribution Requirements

Although Roth IRAs have no mandatory distribution requirement, except for an inherited Roth IRA, Traditional IRAs do: You must begin taking annual distributions from these accounts by April 1 of the year after you turn age 70 1⁄2 and receive subsequent annual distributions by Dec. 31. If you ignore the deadlines, you will face a 50% penalty on the amounts you should have taken — on top of the required income tax bite. Ouch … that can put a big crack in your nest egg!

What’s worse, that fissure can grow even bigger, costing you more of your savings because the IRS requires delinquent taxpayers to make up such oversights by taking two minimum distributions the next year. Also, you may miss out on certain tax deductions, exemptions and credits because your AGI may exceed phaseout levels, and you also could incur more taxes on your Social Security benefits.

Disclaimer: Equity Trust is a passive custodian and does not provide tax, legal, or investment advice. It does not endorse or recommend any contributor, company, or specific investments. Any information communicated by Equity Trust Company is for educational purposes only and should not be construed as tax, legal, or investment advice. Whenever making an investment decision, please consult with your legal, tax, and accounting professionals.