Congress set up individual retirement accounts to encourage you to save for your later years. This encouragement takes the form of tax-deferred or tax-free earnings, deductions for contributions to a traditional IRA and penalties for distributions before age 59 1/2. If you want to reverse an IRA distribution, you normally have 60 days to act, but reservists may qualify for more time.
The IRS taxes all distributions from a traditional IRA as ordinary income at your marginal tax rate. If you withdraw money before age 59 1/2, the IRS will charge you a 10 percent additional tax unless you qualify for an exception, such as disability or substantial medical costs. You don’t pay taxes on withdrawals from a Roth IRA, but you do face the 10 percent additional tax for premature withdrawals of earnings. The IRS considers any distribution of earnings before the fifth anniversary of your Roth account or age 59 1/2 to be premature.
If you take an IRA distribution and subsequently decide to refund it, you must complete a rollover of the money to the same or another IRA within 60 days to avoid possible taxes and penalties. The IRS is strict about the deadline but will grant you an extension if the money was frozen in an account at an insolvent bank. You may also appeal the 60-day deadline if you missed it through no fault of your own. You’ll have to prove it was all the bank’s fault and that it would have been a legal rollover had it not been for the bank’s mistake.
Qualified Reservist Repayments
Reservists called to duty after September 11, 2001 qualify for penalty-free IRA distributions if they were on active duty for more than 179 days. You must have made the withdrawal during the period of active duty. The IRS allows you to repay these distributions during the two years following the end date of your active duty. You can make this repayment even if it causes you to exceed the IRA annual contribution limit, which in 2013 is $5,500, or $6,500 if you’re age 50 or older.
The IRS also gave a repayment exception for IRA distributions due to natural disasters, but this exception has expired. If you refund a distribution, and in the process convert the money from a traditional IRA to a Roth IRA, you will owe taxes on all but the nondeductible amount of the conversion. Nondeductible contributions arise when you or your spouse are enrolled in a workplace retirement plan and your income exceeds certain limits. You don’t have to pay the 10 percent additional tax on early withdrawals if you make a Roth conversion within the 60-day deadline.
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