How To Do A Make a Tax Free IRA Withdrawl

We’ve discussed in the past how it’s possible to eliminate quarterly estimated tax payments by using a withdrawal from your IRA.  But did you realize that you can actually put this method in motion without actually increasing your income?

Wait a minute… did you just catch that?  I’m telling you that you can eliminate your withholding or quarterly estimated taxes by using a withdrawal from an IRA – and that you can do this without having to recognize income from the IRA withdrawal.

It’s a little tricky, but if you’re not too faint of heart, this could actually be a cool little maneuver.  What you do is to take a withdrawal from your IRA, and on the withdrawal slip indicate that you want the entire withdrawal withheld for taxes.  Then, within 60 days, replace the funds (from another, non-IRA source) into either that same IRA or another IRA – effecting a sixty-day rollover.  End result: taxes withheld, no income, no penalty.

While it might seem crazy to assert that you can have taxes withheld from a distribution that was negated by a 60-day rollover, but the IRS allows you to do a tax-free rollover of a distribution that has been sent to the IRS as withheld income tax, by using substitute funds (see Rge 1.402(c)-2, A-11).

How could this be a cool maneuver?  Take the factors into account:

  • When you withhold tax from an IRA distribution, the IRS considers that it has been withheld over the course of the year, so timeliness of withholding isn’t important: you could have your entire tax burden withheld on December 31 if you wanted.
  • If you are self-employed or otherwise in complete control of your income, you can eliminate withholding and/or estimated tax payments completely, by saving up the equivalent of withholding through the year and then pulling the trick outlined above toward the end of the year.

You’d be able to very accurately calculate your tax payments, reducing the loss of income that comes along with over-withholding through the year.  This way you can invest the money that you’d otherwise be sending in quarterly installments, and at the end of the year make one large payment from your IRA, and roll-in your withholding stash.

It should be noted that, while this is a valid option to consider, there are pitfalls that could really cause you problems.  Just forgetting to do the IRA withdrawal (withholding the withdrawal to pay tax) one time can result in some very serious penalties.  Furthermore, missing the 60-day deadline for completing the rollover could penalize you further with the 10% early withdrawal penalty.

I would not suggest doing this maneuver on a regular basis – it should be one of those tools that you have available if you get caught in a pinch.  The penalties for screwing it up are too severe, and the chances of screwing it up are plenty.

About the author

Jim Blankenship, CFP®, EA

Jim Blankenship is the founder and principal of Blankenship Financial Planning, Ltd., a financial planning firm providing hourly, as-needed financial planning and advice. A financial services professional for over 25 years, Jim is a CFP professional and has earned the Enrolled Agent designation, a designation that qualifies him as enrolled to practice before the IRS. Jim is also a NAPFA-registered financial advisor, which designates him as a Fee-Only Financial Advisor.

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  • Ralph –

    You might be able to avoid the 10% penalty to the extent of your medical bills that are not otherwise covered by insurance. Beyond that, you will likely owe the 10% penalty on the remainder of your withdrawal, in addition to income tax. I’m assuming that you have used all of the money to pay your current bills and/or it has been more than 60 days since you withdrew from the IRA…?

    If you have some of the money left over and it has been less than 60 days since you withdrew it, you would be eligible to put that money back into the IRA (or another IRA), and avoid the tax and penalty in that fashion. Other than that, I don’t have any other tricks to offer for you.

    Hope this helps –


  • Hi, I had to take $47,500 out of my IRA (I did not let them take out any tax) to keep my house (pay taxes and mortgage and bills). I also have a separate 401(k). I am 52. I work (not on disability) but have parkinsons, so i am disabled. I am not making what i usually make in sales. I do have a daughter in college, and i spend lots of cash on medical expenses and prescriptions each year. I wish to avoid the 10% penalty, and also of course want to minimize the tax when i do my 2011 taxes. Any hope?

  • Heidi –

    The difference with RMDs is that you must recognize the income – so you can’t replace the funds withdrawn (as was the case with the example in my article).

    However, in the situation you’ve described, if the individual were to have the entire RMD withheld for taxes then a proportionate amount could be deducted for an employer plan or placed in a non-deductible IRA.

    Here’s how I think it would play out: if the RMD was $5,000 (for example) and the taxpayer is in the 33% bracket, then withholding $5,000 of recognized income would result in $10,000 of otherwise untaxed income from all other sources.

    This is because that $5,000 of tax withheld would be used to pay the tax (normally) on $15,000 of income – but you’ve only increased income by $5,000. So $10,000 of income elsewhere is essentially untaxed. So the tax that would normally be paid on that $10,000, which would be $3,300 in the 33% bracket, could be used for retirement plan purposes and the net-net on income would be equal.

    Nothing tricky really happened there, you are just stacking the withholding in one place rather than spreading it around. And if the money was contributed to a tax-deducted account (such as the 457 or 403b), there would be another reduction in tax via the withheld contribution (if $3,300 was contributed and therefore income is reduced, tax would be reduced by another $1,089, or 33% of $3,300).

    Hope this helps and doesn’t just make the water muddier…


  • Hi Jim,
    Your article was very helpful! Thank You.
    I’m a Fee Only Financial Advisor near Seattle, WA.
    Does this work for required RMD’s also?

    My client just inherited her mom’s IRA and is now continuing the RMD’s. They don’t want the RMD’s and are struggling to save enough for retirement! They’re over the $179,000 Roth Direct Contribution Income Cap.
    In their situation, can the RMD go straight to taxes and the amount equal to the RMD be used to fund a Non Deductible IRA or a 457/403b plan(through income)?

    Really appreciate your thoughts to help out our clients!
    Thanks for your time. Sincerely, Heidi Davis

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