Risks of IRA Withdrawals and the 60-Day Rule

It's easy to make mistakes when making IRA withdrawals that could cause you to prematurely pay taxes. Let's first define certain terms and then we will study how to guard against these mistakes.

When one IRA custodian directly moves your IRA to another custodian, you don't get to access your money during that transfer. You may move your money in this fashion, directly from custodian to custodian, as often as you desire. This is the preferable way to move money from one custodian to another. So if you are going to make an IRA withdrawal simply to change the firm that handles your IRA, don't do it. Let the two firms take care of it with such a direct transfer.

A rollover deposit is when you physically take possession of the money from one IRA account and deliver to another. You must complete this physical transfer within 60 days or the money you withdraw becomes taxable to you. Moving money between IRAs in this fashion, where you physically move the funds, can be done just once per 12 months. You have to be very careful while doing this because if somehow you forget to redeposit the funds in 60 days, you have to pay tax on your IRA withdrawal and you could have a 10% IRA penalty if under age 59 1/2. If the IRA is an inherited IRA, you do not have the 60-day withdrawal permitted and can ONLY move funds from one custodian to another by way of a direct custodian transfer. In other words, a withdrawal from an inherited IRA is immediately taxable.

In all other cases, if you take necessary precautions, the same 60-day duration allowed for the rollover can prove beneficial. Not only does it allow for a 60-day loan to yourself, it can even be engineered as a year-round loan as the next paragraph explains.

Say, for example that you have $120,000 in your IRA. You could take the $120,000 IRA and split it into six $20,000 IRAs (using a trustee transfer as described above). You can withdraw an amount of $20,000 from your first IRA. In 60 days, you are able to make up for the $20,000 sum by taking a withdrawal of $20,000 from the second IRA and so forth with six IRAs. In this manner, you manage to extend this 60-day rule into a 360-day rule (60 days each x 6 IRAs) to lend yourself money all year round.

Make sure that you do not hold onto any IRA funds for more than 60 days when withdrawing money from any one of the IRAs only once in a year. If it is not essential for you to take possession of your IRA funds, it is alway best to move it between custodians by direct transfer, allowing the institutions to send the money from one to the other.