In the U.S., people drowning in the sea of debt often raise a question if they can clear their debt by using an IRA. Answering their question it is to be said that you are not allowed to borrow money against the IRA, nor allowed for a special exemption from penalties if you have a financial hardship. However, if the financial hardship is due to a qualified expense, such as college expenses or medical expenses exceeding 7.5 percent of your adjusted gross income, then you will be able to withdraw money from the IRA. This will be penalty free, but not necessarily tax free. You have to file the withdrawal amount on your taxes, depending on whether the IRA is a traditional IRA or Roth IRA.
Now let us have a look how to borrow money against the IRA and pay off the exiting debt.
In order to withdraw money from the IRA, collect an IRA withdrawal form from your financial institution and use it. If you intend to use the money toward paying off the debt that meets the standards for a qualified withdrawal, make sure you note that down on the withdrawal form.
Remember, you must follow the proceeds of the IRA distribution to pay off the debt. Also remember to keep accurate records and receipts of the money contributed towards expenses that make it a qualified distribution. These records and receipts can serve as a proof when your tax return is questioned.
In order to determine whether you owe any taxes on your return, fill the first part of the IRS form 5329. Then report the total amount of the distribution on line 1, the amount that is qualified on line 2, and the difference on line 3. If you see any portion on line three that is unqualified then multiply it by 10 percent to calculate your tax penalty and report it on line 4.
If there is any amount of penalty, then copy that to line 58 of your form 1040 of tax return.
Then write the total amount you withdraw on line 15a of your form 1040 tax return. Also write the taxable amount on line 15b of the form 1040 tax return. Remember, in case you withdraw money from a traditional IRA, you have to include the amount as taxable income, even if you do not have to pay an early withdrawal penalty. On the other hand, in case you withdraw from a Roth IRA, you do not have to include the amount as taxable income since it is usually non-taxable.
Hence, to conclude, bear the above mentioned steps in mind to withdraw money from the IRA and to pay off all your debt.
By this point, if you’ve read through much of our site, you’re pretty familiar with the standard Roth IRA, but a lot of people don’t know you also have the option of making a Roth 401(k).
By using the Roth feature in your 401(k) plan, you can put some, or all of your deposits up to $16,500 a year, or $22,000 if you’re over 50. The rules are a little different than what you’re used to with your standard 401(k). You actually receive the tax advantage right now rather than in the end with the traditional Roth. This means you will have to pay tax on it when you withdraw the funds later.
With the Roth IRA, you usually have limits on how much you make a year, but with the Roth 401(k) you don’t have to worry about income limits. Anybody can open a Roth 401(k) as long as your employer offers it, and if they don’t you should make a request to have it added. It doesn’t cost the employer much so it shouldn’t be an issue.
The big advantage of going this route is to hedge against tax increases. You never know how the tax rates will change or what bracket you’ll be in so the Roth 401(k) is a great safety net for a situation where the taxes have raised dramatically. Most people see the tax rates going up soon so now is the time to lock in your money. The goal is to have money in both a traditional 401(k) and the Roth so that you can withdraw money at different times depending on the current tax rates after retirement.
This is the same old theory of not having all of your eggs in one basket, and protecting your retirement funds as much as possible. Here’s a video that explains more:
Fidelity Investments is a well known Boston mutual fund company. They are hugely involved in offering workplace retirement saving plans and Individual Retirement Accounts (IRAs). In the December Roth IRA conversions report, so many investors took advantage of the Roth IRAs tax benefits it lead Fidelity to report a big spike in conversions.
Fidelity has stated that the Roth IRA conversions in 2010 resulted in a 400% increase among its customers compared to 2009. This is caused by the new rules that have just been made effective recently. These rules made it possible for more people to qualify for Roth IRAs. Fidelity also said that almost 30% of Fidelity’s Roth IRA conversions during 2010 took place in the month of December.
If you compare a Traditional IRA vs Roth IRA, you will see that traditional IRA makes people contribute to a particular account involving money that may be allowed to be deducted on their tax returns, and as long as any earnings are not withdrawn, it potentially grows without being taxed.
For Roth IRAs on the other hand, people are made to contribute on an account involving money they already have paid taxes on. This means that the money from this account grows with no taxes. Given that particular conditions are met, retirement withdrawals have no taxes taken out either.
Fidelity Investments’ senior vice president of investor education, retirement, and financial planning, Chris McDermott said that whether investors convert to Roth IRA or not is just the first step in finding out potential ways to maximize their assets by minimizing retirement taxes, and they expect that the conversion will continue through 2011.
Qualified withdrawals for Roth IRA are tax-free. This is their best feature, however, to be a qualified withdrawal, you must be 59 ½ years of age and your account must be open for at least five years. If you withdraw before the age of 59 ½ or before the fifth year of your account, you will be charged for taxes for the earnings withdrawn and the 10% early withdrawal penalty.
Roth IRAs are intended to be long-term retirement savings, but you may go through situations that may require you to tap into you account before the right year and age. Many people may experience this, especially now that the economy is going through twist and turns.
Now the question is, how can you tap into your account before reaching its fifth year or the age of 59 ½? There are some exceptions that Roth IRA may consider for early withdrawals. The following withdrawal will void the 10% early withdrawal penalty:
Funds for un-reimbursed medical expenses are an exception. An un-reimbursed medical expense that surpasses 7.5% of your adjusted gross income (AGI) will exempt you from the 10% penalty.
If you lost your job, funds spent for personal medical insurance will be penalty-free. This also applies if the funds will be for the medical use of your spouse or other dependants.
Disability is another exception that Roth IRA considers. You just have to provide them a proof of your disability to be exempted from the 10% penalty.
Upon the death of the owner, the funds paid by Roth IRA to the beneficiary will not be charged for any penalty.
If the distribution is considered a part of an equal payment program, the person will not be liable for penalty. Remember that the owner must be 59 ½ years old or the distribution has already lasted for five years.
You will also be exempted from the withdrawal fee if the funds will be used to purchase a house. The owner, spouse or dependants must prove that they are first time home-buyer to qualify. A $10,000 withdrawal will be granted.
If the funds will be used to pay a higher education for the owner or dependants, the withdrawal will be penalty free. This exception applies for tuition, fees, books and supplies.
Remember that the given withdrawal exceptions will only exempt you from the 10% withdrawal fee; you may still be liable to pay for the taxes for the earnings withdrawn.
Let’s say you have an early withdrawal of $10,000 to purchase a house. You are qualified to be a first time home buyer, so Roth IRA will exempt you from the penalty. However, if your account is open for less than five years, you will still be liable to pay tax for the earnings withdrawn.
We hope this article will help you save some money. Don’t forget to check out the Roth IRA Conversion Calculator page if you’re considering a change in IRA.