COMMENTARY | There are basically two different types of IRA accounts. The first is the traditional IRA account to which you make contributions, usually with pre-tax money, that will grow on a tax-deferred basis. When you make a withdrawal, it is considered as ordinary income and taxed at the prevailing rate. Sometimes, you will make a contribution with after-tax dollars (non-deductible) and the same rules apply except that part of the withdrawal is not taxable, because it is a return of principal.
The second type of IRA is the Roth IRA and you contribute after-tax dollars. If you have met certain time and age conditions, the withdrawn money is tax-free. One huge advantage of the Roth IRA is that you can access contributed principal at any time, without penalty. This feature provides a certain amount of planning flexibility, available in an emergency that is lacking in other retirement plans.
While I do have a Roth IRA, I also maintain three separate traditional IRA accounts so that I have more over my investments and access to my cash, in the event of an emergency.
The law allows me to take a normal distribution from an IRA and replace it within 60 days. This legal feature would allow me to effectively borrow money from myself, without tax consequences, as long as I replace the money within the 60 day window. In 1998, I needed to have $30,000 as a good-faith down payment on a new home. I didn't have the money on hand, but knew that before the time of closing, that I would have more than enough cash to replace the withdrawal. However, after about a month, I realized that there would be a delay in the closing so I created a second IRA account and arranged for a trustee-to-trustee transfer for half the assets. A few days later, 55 days after my original withdrawal, I took enough out of the new IRA and deposited into the old. That gave me a new 60 day window, and the real estate transactions took place well within the time period and I replaced the funds.
If I did not have a second IRA, I would have had to recognize the $30,000 as a distribution and pay both taxes and penalty on it.
People who are self-employed may also benefit from having multiple IRA accounts because you can use this same technique to pay your income taxes. Normally, self-employed people pay taxes on a quarterly basis, but sometimes cash flow does not permit it. If you pay the money directly to the treasury, you may be charged with late payment interest. If you take a distribution from an IRA, and have 100 percent withheld as taxes, then the government considers that money to be paid equally throughout the year, thereby saving any interest and penalty.
Substantially Equal Periodic Payments (SSEP)
If you are under the magic age of 59 ½, the government imposes a 10% penalty on distributions from an IRA. However, you can elect to make a 72T election which states that as long as you are taking out SSEPs, for the later of five years or age 59 ½, you can avoid the penalty. If you fail to follow the schedule, then the IRS will back date all the payments and impose penalties. If you had two IRAs you could take the SEPP from one, avoiding all penalties, and in the event of an emergency, access the other and pay the penalty applicable only to that distribution.
Sure, there is more paperwork and recordkeeping when there are multiple accounts, but I think that the advantages outweigh the nuisance factors.
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