Reducing Your Tax-Deferred IRAs and Qualified Plans by Taking Distributions Before You Must at Age 70 1/2

If your own IRAs and qualified plans, there looms that day when you turn 70 1/2 and the IRS forces you to begin taking distributions from your tax-deferred account. As we established, there are tax advantages to reducing your tax-deferred assets as much as possible before you die. In some cases, you may not want to wait until you're forced to take distributions before beginning a withdrawal program.

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In general, you can't take distributions from your IRA balance until you're aged 59 1/2 without paying a 10% penalty. However, there are a few exceptions in which you can avoid the penalty (although ordinary income taxes are still due on traditional IRA distributions).

• Your IRA assets can be accessed free of the 10% penalty before you're 59 1/2 in the case of death, disability or first-time home ownership.

• You may also decide to "annuitize" your IRA in substantially equal annual payments calculated over your life expectancy(or the joint life expectancy of you and a beneficiary) before age 59 1/2 without penalty.

• IRA distributions used to pay deductible medical expenses that exceed 7.5% of your AGI.

• Qualified higher education expenses also avoid the 10% early withdrawl penalty.

Consider these last two alternatives especially if your deductable medical expenses are very high or you have children or grandchildren in college.

If you're eligible, you might also consider converting your traditional IRA to a Roth IRA. You would owe ordinary income tax in the year of the conversion; however, you would gain the flexibility to continue your IRA's tax-deferred growth-and potentially income-tax-free distributions.

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Taking Distributions After Age 59 1/2

A strategy for the extremely wealthy aged 59 1/2 or older is to begin spending down tax-deferred balances sooner rather than later, especially if you have large balances and are concerned about the double-taxation issue. To ease the tax burden on lump sum distributions from employer-sponsered plans such as 401(k)s, ask your tax advisor if you're eligible for forward averaging, a strategy that may reduce your cumulative taxes.

You may also choose to employ an annual gifting strategy to further reduce the value of your estate. You can gift upto $10,000 per person, per beneficiary($20,000 per couple, per beneficiary) anually, gift-and estate-tax-free.

The bottom line:In some circumstances, you may not want to wait until you're forced to take distributions at age 70 1/2. Consider taking advantage of the opportunity to spend down your tax-deferred assets-perhaps even before you turn 59 1/2.

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Heed The Signs

Any one-or a combination -of these strategies may be just the ticket for your tax-deferred assets. Talk with your tax and legal advisors and your financial consultant to determine your best route to making the most of the tax-deferral advantage.

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The Potential Tax Benefits Of Forward Averaging

If you take a lump sum distribution from your retirement plan and you meet certain other criteria, you may qualify for forward averaging-a technique that lets you calculate and pay your taxes as if you have recieved the distribution over 10 years. You must pay the entire tax in the tax year of the distribution; however, forward averaging may result in a lower cumulative tax liability.

To qualify for 10-year forward averaging, you must have been at least 50 years of age by Jan. 1, 1986. Tax rates from 1986 are used to compute the tax due on your distribution.

You may take advantage of forward averaging only once in your lifetime. See your tax advisor if you are interested in exploring the possibility of using this technique.

Note:Another forward-average technique, five-year forward averaging, is not available for distributions made after Dec. 31, 1999.