Penalty-free IRA withdrawal requires age of 59½
Q: I was born October 30, 1958. This means I will turn age 59½ in April of 2018. My question relates to my IRA. There is a penalty for early withdrawal before age 59½. I cannot find an answer to how the IRS measures that. It would be best for me to take a distribution in January 2018, which is within the same tax year that I turn 59½, but I need to know if I have to wait four months into 2018 before taking a penalty-free distribution.
You will have to wait until you actually reach age 59½. The tax law does have its own definitions of words, and one reasonable interpretation would be that any distribution in the year you turn 59½ would be acceptable to avoid a penalty.
Unfortunately, the law is actually clear on this point, and it requires that you wait until six months after reaching your 59th birthday, which would push you out into April 2018.
I suggest that you wait until May 1, 2018 to take a distribution. There are exceptions to the early withdrawal penalty, so you may want to look into those exceptions. But if you cannot meet any of the exceptions then you should wait.
Q: What is a dynasty trust? I have a friend who says that he has one and he seemed to think we all knew what it was. Is it a common thing?
A dynasty trust is a trust that will be in existence for a very long time. The term is not an official legal term, just a name used by estate planners.
Most trusts are not dynasty trusts, so in that sense they are not common. Trusts are often established for a specific purpose, and that purpose can be satisfied long before the term of a dynasty trust.
The common law has a concept called the rule against perpetuities that is used to limit the term that a trust could last. This term is generally a life in being plus 21 years (although minor differences existed by state law).
This means if I want to establish a trust for my four children, the term of that trust could last for the entirety of their lives (as they are each a “life in being”) plus 21 years.
Many states have now eliminated or modified the rule against perpetuities. More than half of the states either have no limit on the term of a trust or a limit that is substantially longer than the common law rule.
With an unlimited trust term, a couple could establish a trust for the benefit of their children, grandchildren, greatgrandchildren and so on. Such a trust would fit the term dynasty trust well.
But most people do not want a trust to tie up trust property for so long, and may have no interest in attempting to benefit generations currently unknown to the grantor of the trust.
If you think a dynasty trust might be right for you, I would suggest scheduling a meeting with an attorney who specializes in estates and trusts.
Q: I am paying college costs for my child, and I would like to use a distribution from my IRA to pay January tuition bills. There is an exception to the early withdrawal penalty for “higher education costs.” Does this apply to college costs of a child of the IRA owner?
Yes it does. The higher education cost exception applies to costs incurred for the owner, his or her spouse, children, and grandchildren.
As you probably know, the exception means only that you will not have to pay the 10 percent penalty for an early withdrawal. The distribution itself will still be subject to inclusion in your regular taxable income.
You will have to complete IRS Form 5329 to report the early distribution and to show that you qualify for an exception to the 10 percent penalty. This form will be included on your return for the year of the distribution.
In Part I of that form you report the amount of the taxable distribution on line 1. Then enter the number “08” on line 2. That number is the code for the higher education exception.