Dear Readers,
I received a number of letters in response to my column concerning the consequences of taking early withdrawals from your IRA.

There are actually a number of "excuses" which allow you to access your IRA account prior to age 59 1/2 and avoid the 10% early withdrawal penalty. (You will still owe taxes if your withdrawals are coming from a traditional IRA where the contributions were tax-deductible.)

Paying for your own or a child's college education is one of the exceptions. Others include withdrawing up to $10,000 for a first-time home purchase or withdrawing as much as you need to cover medical expenses that exceed 7.5% of your adjusted gross income (AGI).

Then there's simply what I call the "I-need-the-money" excuse. This is trickier than it sounds because you have to use one of three IRS-provided methods to figure out how much you can withdraw each year. (In other words, you do not get to take out any old amount you want.) And once you start this process, you cannot stop the withdrawals until either you reach age 59 1/2 or you have taken them for 5 years -- whichever takes longer.

In the above-referenced column, the reader who was using this method (called "substantially equal periodic payments" in IRS-speak) found herself depleting her retirement account much faster than anticipated. In fact, because she was locked into withdrawing $30,000 a year from her IRA, Anne was close to wiping it out entirely. That's because a combination of unprecedented events which had cut the value of her IRA investments in half: an economic downturn, followed by terrorist attacks, followed by corporate accounting scandals, followed by election-year politics.

Based on this, I said her only choice was either to continue the withdrawals from her IRA and hope it lasts long enough for her to keep her commitment or just stop her withdrawals, bite the bullet, and pay the 10% penalty.

The IRS was not particularly sympathetic. Their position was that she chose to tap her IRA early and then chose a method which requires a fixed withdrawal amount. Tough luck that the market went into a nosedive.

However, it appears this inflexible stance has mellowed since I wrote that column. I know for a fact there has been a flurry of letters and emails from financial advisors and taxpayers, pleading for leniency.

The IRS told me this entire subject "is on our priority list for guidance," meaning the Treasury Department is going to take a look at whether it makes sense to be so rigid. At this point, the IRS' "informal" position is that if you have "unforeseen circumstances," such as a sharp decline in the stock market, which make it impossible for you to withdraw the full amount you are supposed to, they will not hit you with a 10% penalty, provided you take out as much as you can.

In addition, an IRS Private Letter Ruling has now allowed an individual who wanted to start a penalty-free series of withdrawals to adjust withdrawals based on the changing value of his IRA under certain circumstances.

But let's switch gears for a moment. Suppose Anne wanted to continue her withdrawals, but feared her IRA would run out of money. The IRS says she could roll money over from another IRA and make a cash infusion.

As for Anne, whose case started this whole discussion, several of you had reactions similar to those expressed by "Jeff" and "James" and simply suggested she reduce her expenses and reinvest her withdrawals elsewhere.

Here you go:

Dear Gail

In reading the article "Think Long and Hard About Tapping Your IRA Early" I was expecting you to suggest another course of action.

If I were in that situation I would have look at cutting back on expenses and reinvesting the money that was being paid out monthly. Perhaps part of it could go into the Roth IRA.

Just because the rules say she can't stop or change the distribution amount, it doesn't mean that she has to spend the money.


Dear Jeff,

You're right. Unfortunately, in real life it is rarely easy to simply "cut back on expenses." Most people have a number of fixed expenses which cannot be eliminated or reduced unless they file for bankruptcy: mortgage/rent, utilities, insurance, food and pre-existing debt payments.

Moreover, these fixed amounts tend to make up the biggest chunk of their monthly bills. While it's possible to stop eating out, going to movies, buying new clothes, watching cable TV, for most folks eliminating these will just reduce their expenses marginally.

Unfortunately, in Anne's case she needs most of her IRA withdrawal in order to make ends meet.

But even if Anne were able to reinvest some of the money elsewhere, the real tragedy is she loses one of the biggest benefits an IRA offers: tax-deferred (tax-free in the case of a Roth) growth. It's kind of a Catch-22: Unless you have income from a job -- and Anne doesn't or else she wouldn't be taking money from her IRA -- you're not eligible to contribute to any sort of retirement plan which offers tax-deferred growth.*

With the help of CCH, a leading provider of tax information, I worked up a simple example to illustrate this. (Please spare me the e-mails about long and short-term capital gains rates, projections about future income tax rates, etc! As I said, I'm making some assumptions.)

Assume you're single and the only income you have this year is the $30,000 you're withdrawing from your IRA. That puts you in the 27% tax bracket. Income tax of $4,446 reduces this amount to $25,554.

Now, suppose a long-lost aunt passes away and leaves you a pile of money, meaning you no longer need the withdrawals from your IRA to make ends meet. Since you still have to take it out in order to avoid the penalty, you decide to invest the entire after-tax amount in a portfolio earning 8% compounded annually. You're not working, so this money can only go into a taxable account; each year you'll pay 27% tax on the earnings. After 20 years, after taxes, you will end up with roughly $74,000.

Now, imagine another scenario in which your aunt dies before you start your IRA withdrawals. With the inheritance, you no longer need to tap your IRA, so you leave the $30,000 in the account. If it earned the same return as the taxable investment in the previous example -- 8% compounded annually -- after 20 years the $30,000 in your IRA would have grown to $139,829.

If you withdrew the entire amount that year and paid taxes at the 27% rate, you net about $103,000 -- considerably more than the after-tax return you got on your taxable account. That's the real loss you suffer when you take money out of an account like an IRA or 401(k).

The advantage of tax-sheltered growth is only magnified by a Roth IRA: you never owe income taxes on your withdrawals (provided you leave the money in for 5 years and until you have reached 59 1/2).

It comes down to this: given the same return and timeframe, money in a tax-sheltered account will always grow faster than in a taxable account.


*The exception is that a non-working spouse is eligible to contribute to an IRA, even if the other spouse is employed.


If she has to keep taking the money out of her IRA to avoid the penalty, can't the lady just put the extra money in savings (whatever vehicle is best for her situation) or, if she is married and her spouse is working, can they put the money in a new IRA?


Dear James,

Yes, Anne could invest "extra" money in another type of account, but she will lose the tax-deferred growth her IRA provides. Thus, on an after-tax basis, she'll end up with less money.(see example above.)

I like your suggestion that Anne contribute any excess money to a spousal IRA. However, this would only help her if: a. she doesn't need all the money being withdrawn and b. she is married.

And keep in mind, the maximum amount she is eligible to contribute to an IRA is $3,000 or $3,500 if she's over age 50. So any amounts in excess of $3,000 would have to go into a taxable account.


Dear Gail Buckner:

I just read your article about the lady who tapped her IRA early at $2500 per month and now cannot stop the process without incurring the 10% tax penalty.

Isn't one option for avoiding or reducing this problem to have more than one IRA account? That way if you need the money, you only tap one account and at most could only use up a fraction of your savings, instead of the entire amount?



Dear Wayne,

I understand where you're going with this. Had Anne divided her IRA into two or more separate IRAs before she started the withdrawal process, she could have simply tapped into one of them and left the others growing tax-deferred.

Keep in mind, you can divide a single IRA into as many separate IRAs as you want. This comes in handy, for instance, if you want to name a different beneficiary for each one. However, this approach can get expensive if your IRA custodian charges a fee for each IRA you have.


Dear Gail --

You write that you can withdraw up to $10,000 from your IRA before you're age 59 1/2 and NOT have to pay that 10% penalty if you use the money toward the purchase of a first-time home.

Is my spouse also eligible to withdraw $10,000 as well? This means we'd have a total of 20,000 between us for a first-time home.



Dear John --

You are correct. Each person is permitted to withdraw a maximum of $10,000 from their IRA penalty-free, provided the money is used to pay for a first-time home. Keep in mind, you can do this only ONCE in your lifetime.

And if you are taking the money from a traditional, tax-deferred IRA, you will still owe income tax on the amount withdrawn. So you and your wife will actually end up with less than $20,000.

The interesting aspect of this is the definition of "first-time home" buyer: It means anyone who hasn't owned a home in the past two years. So, suppose you went through a divorce several years ago and the house you and your ex jointly owned was sold to divvy up the marital property. As long as you have not been a home "owner" for the past two years, you are now eligible to tap your IRA to come up with the down payment.

And here's another wrinkle: the "first-time home" being purchased doesn't have to be the IRA owner's home. It could be your child's, a grandchild's or your parents'.

Hope this helps,


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The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.