IRAs & Cash Distribution Rules
An Individual Retirement Arrangement is designed to be a retirement savings vehicle, but IRA owners may access cash from an IRA at any time. The distributions may be subject to income taxes and penalties depending on the type of IRA (traditional or Roth), age of the owner and the length of time the IRA has existed.
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Normal Distributions
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Normal distributions are considered distributions taken after the owner turns age 59 1/2. This is true for a traditional or Roth IRA, although there are some differences regarding the distributions. Traditional IRAs take the cash and treat it as income in the year the distribution was taken. The year the investor reaches age 70 1/2, a required minimum distribution must be taken every year thereafter. A Roth IRA grows tax-free, so normal distributions are not taxed and there is no required distribution as the investor ages. One other restriction to a normal distribution for a Roth IRA is that the investor must own the IRA for at least five years before taking distributions to avoid early withdrawal penalties. All cash distributions not considered normal are subject to the 10 percent tax penalty.
Exempted Distributions
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Distributions taken before age 59 1/2 or the Roth five-year requirement may be exempt from a tax penalty if the investor qualifies for an exemption. Exemptions include using $10,000 for buying a home or using unlimited cash distributions for sending a family member (including the investor himself) to college. The IRS also has hardship exemptions that include taking cash distributions to pay for extreme medical expenses, foreclosure prevention or eviction prevention. The exemption does not discount the income taxes owed on the distribution, just the penalty.
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IRS Reporting
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Cash distributions taken from any IRA generate a Form 1099-R. The gross amount distributed is listed in Box 1. Box 2a tells the IRS (and the investor) whether the distribution was normal, qualifies for an exemption or is a prohibited transaction. Normal distributions have Code 7 with exempted distributions maintaining Code 2. If Box 2a states a Code 1 or 5, there will be a tax penalty for a non-exempt early withdrawal or a prohibited transaction such as a loan. IRA cash distributions are recorded on Line 32 of the IRS Form 1040 or Line 17 on Form 1040A when filing taxes.
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