accounts (IRAs) have become part of nearly everyone’s financial plans.
Consequently, information about the benefits of putting money into these
accounts is common. But the other side of IRAs — withdrawals — has received
Do you know when you
can take penalty- free early withdrawals? And have you thought about what
withdrawal strategy will work best for you during retirement? Factors such as
your age, health and, in some cases, life expectancy affect your options. Let’s
look at some of the rules governing IRA distributions while reflecting on how
they could affect your situation.
For tax purposes, you
generally must consider traditional IRA distributions as ordinary income when
distributed to the recipient (you during your life or your spouse or other
beneficiary after your death).
For maximum tax
safety, keep in mind two key ages, 59 1/2 and 70 1/2, as you develop your IRA
distribution plan because:
Taken Before Age 59 1/2
Although you generally
cannot withdraw funds from your IRA before age 59 1/2 without incurring a 10%
penalty tax, this rule does have exceptions. The 10% tax does not apply to
Made after the IRA
owner’s disability or death,
Taken to pay qualified
higher education expenses,
Used for a first-time
home purchase (up to $10,000),
Treated as a return of
a nondeductible contribution, or
That are part of a
series of substantially equal payments made beyond your life expectancy or the
life expectancy of you and your beneficiary.
for the life expectancy exception are strict. To use this exception, take
distributions through an IRS-approved method and elect to receive at least one
distribution payment annually. Payments must continue for at least five years
or until you reach age 59 1/2— whichever is longer. But this five-year rule
does not apply if the IRA owner becomes disabled or dies.
Taken After Age 59 1/2
you are older than 59 1/2 you can take distributions from your IRA in any
amounts you choose. But remember, any funds distributed are taxed as income.
Also, keep in mind that once funds are distributed, you lose the ability to
defer the tax on future income from those funds.
minimize your income tax, consider taking distributions in years you have
relatively little taxable income or many deductible expenses, such as medical
costs and charitable contributions.
people these days work into their late 60s or early 70s. If you plan to work
beyond standard retirement age, consider putting off withdrawing IRA funds
until the law requires you to begin taking minimum distributions at age 70 1/2. This
strategy maximizes your funds’ tax-deferred growth.
Taken After Age 70 ½
must begin taking minimum distributions by April 1 of the year following the
year you turn 70 1/2. This date is
known as your required beginning date (RBD). If you wait the extra year, rather
than beginning when you reach age 70 1/2, you must take a double distribution
the first year.
you must choose a distribution method and take minimum distributions in at
least annual installments. This will involve scheduling distributions according
to a chart referencing your life expectancy or the life expectancies of you and
a designated beneficiary. If you designate multiple beneficiaries, IRA rules
use the oldest beneficiary to determine the maximum distribution period.
your RBD, you must take minimum distributions according to either the recalculation method or the term certain method, whichever
you prefer. Once selected, the method you choose is irrevocable and applies to
all subsequent years.
recalculation method. This is the
default method for most IRA plans. With the recalculation method, you calculate
a new life expectancy figure each year based on your age and a tax code
formula. The formula is based on a table of joint life expectancies of you and
your beneficiary. If the beneficiary is a person other than your spouse, the
maximum difference in ages that can be used to calculate the joint life
expectancy is 10 years.
advantage of the recalculation method is that it stretches out the period for
minimum distributions, allowing more tax-deferred growth for your funds. On the
down side, if either person factored into the recalculation dies, the
deceased’s life expectancy becomes zero. If this happens, payments
term certain method. With this
method, you calculate a life
expectancy figure based on your RBD.
For example, if your life expectancy is 20 years, you must distribute 1/20 of
your account in the first year. After that, you reduce the denominator by one
each year. Although the term certain method generally defers less and increases
minimum distributions compared with the recalculation method, it continues
using the same joint life expectancy tables to figure distributions even after
one person dies.
distribution method you use, several factors affect minimum distribution
amounts. Seek professional advice and take great care to calculate minimum
distributions accurately because failure to withdraw the proper amount in any
year could result in a 50% excise tax on the shortfall.
figure the minimum amount for a given year, consider all your IRA balances as
of Dec. 31 of the previous year. But while you must aggregate all IRAs for
purposes of computing your minimum distribution amount, you can take the
distribution from any single IRA or combination of IRAs.
you die before your RBD, the general rules say that the remaining balance in
the IRA must be fully distributed to a beneficiary within five years of your
death. But if your benefit is payable to a nonspouse beneficiary and will be
distributed throughout this person’s life, distributions must begin within one
year of your death. If your spouse is the beneficiary, your IRA balance may be
rolled over tax-free to his or her IRA.
If you die on or after
your RBD, distributions must generally be made to the beneficiary at least as
rapidly as they were being made to you according to the method used before your
Yourself From Penalties
from your IRA can be complicated. The last thing you need to find out during
retirement is that withdrawals you’ve been counting on will be reduced by
penalties. Careful planning with your tax advisor can safeguard your IRA
benefits, so call us today.