Many people have money locked into deductible, or traditional, IRAs. It's so close, and yet so far away, unless are at least 59 1/2. At least, so it seems.

In this day of high unemployment, uncertainty in the world economy, and historically low tax rates, I've had plenty of questions about how to tap into IRAs.

Contrary to popular belief that there is no exception to the 10 percent penalty for general financial or economic hardship, you are allowed penalty-free withdrawals for certain hardship circumstances. Let's go over the do's and don'ts, starting with the don'ts.

No-no's

Don't look to your IRA first when you run low on cash. The general rule of thumb I give clients is to plan on losing one-third of an early distribution to taxes. If you live in Kentucky, Illinois, and Missouri, IRA distributions are generally not subject to taxation, so the bite will be a little less. But check with your financial advisor to be sure. In working with clients, our goal is to find creative strategies for cutting costs and tapping into other sources of cash flow. We try to do almost anything in order to leave the IRA alone. You first should almost always cash in after-tax funds — Roth IRAs and non-taxable 401(k)s.

Don't borrow from your IRA. While it's permissible to take tax-free loans from 401(k)s and other qualified plans, a loan from an IRA is considered a prohibited transaction. That means your IRA will lose its tax-deferred status and the full balance will be deemed distributed as of the first day of the transaction year. You will owe income taxes and penalties on all pre-tax contributions to your IRA.

Don't be ignorant of what constitutes a prohibited transaction. Other prohibited transactions you must avoid include: using your IRA as security for a loan, selling property to it, and buying property for personal use with IRA funds. By engaging in any of these activities, you would be subject to the same tax and penalties as for borrowing from your IRA.

Can-do's

First-time home buyers — You can take up to $10,000 penalty-free from your IRA (for each spouse) to purchase a home if you use the money to pay qualifying costs within 120 days. This is a lifetime limit and must be for your principal residence. By the way, this doesn't have to be your first home, but you (or your spouse, if married) cannot have owned a principal residence within the last two years.

Higher education — Your IRA withdrawal will be penalty-free if used for tuition, fees, books, supplies, and (for students enrolled at least half-time) for room and board. The student can be the IRA owner or his/her spouse, children, or grandchildren.

Hardship circumstances — Be sure to check with your financial advisor before tapping your IRA due to hardship because each situation has specific requirements that must be met to qualify. Removing assets from your IRA because of to these events will not cause a penalty:
• Payment of excess unreimbursed medical expenses.
• Payment of medical insurance premiums while unemployed.
• Total and permanent disability.
• Distribution of the IRA assets to a beneficiary after you die.

60-day rollover rule — You can roll funds from one IRA to another one time per year. While you cannot borrow from your IRA, you may use the funds short-term during this period. There are a few caveats to doing this:
• You must be able to replace all the funds at the end of the 60 days.
• When you receive the funds in a rollover, the plan provider will withhold income taxes, so you must be able to replace the taxes withheld.
• Any funds not rolled over within 60 days will be subject to taxes and, if you're younger than 59 1/2, penalties.
• You should be very careful not to appear to be borrowing money from your IRA. In a recent case, the court found that withdrawing money from an IRA to use in a business, and then replacing it within 60 days, was equivalent to borrowing from the IRA

72(t) payments — Also known as Substantially Equal Period Payments or SEPPs, you can take money out of your IRA penalty-free at any age as long as you follow these complicated rules and take payments for five years or at 59 1/2, whichever comes later. See your financial advisor for assistance with calculating 72(t) payments — named because they are located in section 72(t) of the tax code. This method generally works best for IRA owners in their mid- to late-50s who are confident that they can maintain the payment schedule for five years. Information: www.72t.net.

Keep in mind that these exceptions are for the early-withdrawal penalty only — you still have to pay the income taxes. When planning with clients, we always keep an eye on the tax bracket. It's not an all-or-nothing proposition when taking money from your IRA, so plan to try to keep your taxable income in the same bracket as it would be without the distribution. For example, the 15-percent tax bracken in 2010 ends at $68,000 of taxable income for couples. If you will have $35,000 of taxable income, taking another $33,000 will cost you only 15 percent. Anything above that will be taxed at 28 percent — almost double!

Miscellaneous

Here's one last tip that didn't fit anywhere else: If you are age 55-plus and have separated from service at a company where you have a 401(k), you may not want to roll it out to an IRA. That's because you can take penalty-free distributions from your 401(k) under these circumstances, while you would have to wait until age 59 1/2 if you rolled the money into an IRA.

Finally, to let the IRS know that you used the retirement money early for a tax-acceptable purpose, file Form 5329. When you report your withdrawal here, you'll also enter a code, found in the form's instructions, that lets the IRS know the distribution is penalty free.

Johanna Fox Turner, CPA, a Certified Financial Planner and Registered Life Planner (www.kinderinstitute.com) , is owner and Investment Advisor Representative of Milestones Financial Planning, LLC, 907 Paris Road in Mayfield. She is president of Johanna Fox, CPA and the Mayfield-Graves County Chamber of Commerce. She can be contacted at jft@milestonesfp.com, 270-247-0555, 800-991-2721, or at www.milestonesfp.com.