Hot Topics! IRA Recharacterizations & Penalty-Free Withdrawals

The Tax Cuts and Jobs Act repeals the special rule that allows IRA contributions to one type of IRA (either traditional or Roth) to be recharacterized as a contribution to the other type of IRA. For example, a conversion contribution establishing a Roth IRA during a tax year can no longer be recharacterized as a contribution to a traditional IRA which in effect results in unwinding the conversion.

Recharacterization is still permitted in other situations. For example, an individual can still make a contribution for a year to a Roth IRA and before the due date for the individual’s income tax return for that year, recharacterize it as a contribution to a traditional IRA. In essence, recharacterization provisions can no longer be used to unwind a Roth conversion.

Penalty-Free Withdrawals from IRAs Generally, if the taxpayer is under age 59½, he or she must pay a 10% additional tax (10% in addition to any regular income tax on the amount) on the distribution of any assets (money or other property) from a traditional IRA. Distributions before age 59½ are called early distributions. The 10% additional tax applies to the part of the distribution that is included in gross income. There are certain distributions a taxpayer can receive before age 59 ½ without paying the early distribution penalty.

A taxpayer may not have to pay the additional tax for one of the following situations:

  • The taxpayer has unreimbursed medical expenses that are more than 10% of adjusted gross income.
  • The distributions are not more than the cost of medical insurance due to a period of unemployment.
  • The taxpayer is totally and permanently disabled.
  • The taxpayer is the beneficiary of a deceased IRA owner.
  • The taxpayer is receiving distributions in the form of an annuity.
  • The distributions are not more than qualified higher education expenses.
  • The taxpayer uses the distributions to buy, build, or rebuild a first home.
  • The distribution is due to an IRS levy of the qualified plan.
  • The distribution is a qualified reservist distribution.