Tax Attic: Expectations that apply to IRA accounts

Last week’s Rockford City Council meeting was an eventful one. We unanimously passed a motion instructing Mayor Jazwiec to sign a contract, with a caveat or two, with the Michigan Municipal League (MML) to conduct a nation-wide search for a City Manager. The MML brings much expertise to the search process. They will conduct several group discussions here in Rockford to compile a profile against which potential applicants will be judged. The Council plans to meet soon with the MML representatives to clarify the procedure. The entire process is expected to take several months. Allow me to say a word of “thanks” to Interim City Manager Dave Jones and Deputy City Manager Chris Bedford for their loyal and dedicated work on behalf of all the residents of Rockford during this time of transition. It was one year ago, later this month, that City Manager Michael Young took his leave from our presence. Dave and Chris have kept that transition from turning into turmoil. As the former Mayor, I was fortunate to work with both of them on city business. It was a pleasure, Dave and Chris.

For the most part, taxpayers who withdraw funds from a retirement account under the actual day they turned the age of 59 ½ will pay a 10% penalty. There are, however, several ways to legally make withdrawals and have the penalty automatically waived. Some of the exceptions apply only to Individual Retirement Accounts. Some of the exceptions apply only to qualified retirement accounts like 401ks. Some exceptions apply to both IRAs and qualified retirement accounts. Let’s go over the exceptions that apply only to IRA accounts.

First, a taxpayer who is totally and permanently disabled and under the age of 59 1/2 can take distributions without incurring the 10% penalty. The common definition that we, as tax professionals, use for total and permanent disability is a person who is drawing social security disability payments. The State of Michigan also uses that definition when allowing special deductions and credits. A gray issue arises when the taxpayer has applied for disability but has not been approved. I have observed that it can take several months or even a year or two for an applicant to get final approval even in cases that seem to be beyond doubt of disability. While waiting for the social security to start, life’s expenses continue to accumulate and the only money available to the applicant may be in an Individual Retirement Account (IRA). The decision is made to take a withdrawal. Our professional stance has been that if the applicant has a doctor declaration that he is disabled, we can allow disabled status as of the date of the doctor’s letter. The Social Security Administration will, in almost every case, eventually allow disability status and payments back to the day of the original application. It’s reasonable to allow the to disability exemption to stand.

Second, a taxpayer who takes a withdrawal to pay higher education expenses for the taxpayer, spouse, child or grandchild will not be assessed the 10% penalty. The definition of higher education expenses is quite wide-ranging. The student must attend school at least on a half-time basis. The expenses can include tuition, books, equipment, fees, and room and board. Interestingly enough, the room and board expense amount can be used even if the student lives at home. Each school publishes on the school’s website the amount it charges for room and board. The amount can be used in the higher education expense calculation. The only caveat is that the expenses must be paid in the same year that the distribution is taken from the IRA.

Third, a taxpayer can withdraw up to $10,000 to use in helping to purchase a home. The taxpayer must qualify as a first-time homebuyer. The definition of a first-time homebuyer is unique in that the taxpayer just does not have to have owned a principal residence in the last two years to qualify. If the taxpayer is married and both spouses qualify as first-time homebuyers, each of them may qualify to withdraw $10,000. The $10,000 per person withdrawal is a lifetime limit.

Fourth, a taxpayer is allowed to take distributions and convert those distributions to a Roth IRA at any age without paying the 10% penalty. There is a caveat, of course. To not be subject to the 10% penalty, the amount of the IRA that is converted must remain in the Roth for at least 5 years. Each conversion has its own 5 year holding period. However, there is a process in place where the funds converted can be re-characterized back to the original IRA with no penalty. In fact, there is a process in place that a re-characterized amount can be reconverted back to a Roth IRA. In other words, a taxpayer converts funds from an IRA to a Roth. He then can re-characterize the Roth funds back to the IRA. He can then reconvert the IRA funds back to the Roth IRA. Mercifully, each of these transactions is penalty free. There are more exceptions and we will discuss those situations in future articles. In the meantime, This is Jerry Coon signing off.


Jerry Coon is an Enrolled Agent.

He owns Action Tax Service on Northland Dr in Rockford.

Contact Jerry at