By Ian Berger, JD
Here is the situation. The mother is deceased and the father is in jail. He has two minor kids that need the money out of his traditional IRA. Could all of the money be taken out and considered a hardship distribution to avoid the 10% penalty on the entire account?
Unfortunately, no. There is no such thing as a “hardship distribution” with IRA accounts.
A 10% early withdrawal penalty generally applies to IRA withdrawals taken before age 59 ½. But the tax code includes several exceptions to the 10% penalty for withdrawals taken for certain specific reasons. For example, taking a withdrawal to cover the costs of higher education expenses, first time home buying, and health insurance if you are unemployed all qualify for the penalty exception.
However, there is no exception to the 10% penalty for general hardship withdrawals. So, if the father is under age 59 ½, IRA withdrawals are subject to tax and the 10% early withdrawal penalty.
I have a client who is age 43. He started to make Roth IRA contributions in 2015, but he has put in more than he was supposed to. Is there any product he can move it to without penalty? He has about $38,000 in his account.
There is no product that excess IRA contributions can be moved to. Excess contributions are subject to penalty unless they are removed by October 15 of the year after the year the excess contribution was made. Excess contributions can be fixed by withdrawing the excess amount plus “net income attributable” (NIA). NIA is the amount of gain or loss, from date of contribution to date of withdrawal, which is attributable to the excess contribution.
If an excess contribution, plus NIA, is not withdrawn by the following October 15, there is a 6% annual penalty for each year the excess contribution remains in the account.
If your client made an excess contribution for 2018, he should immediately ask the IRA custodian to calculate the NIA. If the 2018 excess contribution, plus NIA, can be withdrawn by October 15, 2019, he would avoid the 6% penalty for that contribution.
If your client made an excess contribution for 2019, he has until October 15, 2020 to withdraw the excess contribution, plus NIA, without penalty.
Any excess contribution withdrawn by the applicable October 15 deadline is not taxable income, but the NIA is taxable income (for the year of the excess contribution) and would be subject to the 10% early distribution penalty (since your client is under age 59 ½). Withdrawn amounts are not eligible for rollover.
Your client should immediately withdraw excess contributions made in years prior to 2018 to stop the 6% annual penalty. (There is no requirement to withdraw NIA associated with those pre-2018 contributions.) Withdrawn excess contributions for earlier years are also subject to tax and the 10% early distribution penalty, and they may not be rolled over.
Finally, your client must file IRS Form 5329 to pay the 6% annual penalty. Form 5329 can be filed with your client’s tax return or it can be filed separately.