The tax laws regarding withdrawals from
individual retirement accounts (IRAs) are complex. To avoid unnecessary
penalties and to ensure you withdraw the funds efficiently, let's
review the basics:
Before Age 59 1/2
In addition to any income taxes that may
be due, withdrawals before the age of 59 1/2 are subject to a 10%
federal income tax penalty. In certain circumstances, however,
the 10% penalty will not be assessed:
- Distributions are made to beneficiaries
after the IRA owner's death.
- Distributions are made to the IRA owner
due to the owner's disability.
- Amounts distributed equal medical expenses
paid in excess of 7.5% of adjusted gross income.*
- Distributions are made to certain unemployed
IRA owners to pay health insurance premiums.*
- Distributions are made for up to the $10,000
lifetime limit for qualifying first-time homebuyer expenses.
- Distributions are made to pay qualified
higher-education expenses for you, your spouse, your children,
or your grandchildren.*
- Distributions are made as a series of
annual withdrawals in substantially equal amounts over the owner's
life expectancy or the joint life expectancy of the owner and
beneficiary.*
* While distributions are exempt from the
10% federal tax penalty, these types of Roth IRA withdrawals are
subject to ordinary income taxes on any earnings. The other Roth
IRA withdrawals are penalty free and federal income tax free.
Between Ages 59 1/2 and 70 1/2
Between these ages, you can withdraw as
much or as little as you like from traditional or Roth IRAs. Both
contributions and earnings withdrawn from a traditional deductible
IRA and earnings from a nondeductible IRA will be subject to ordinary
income taxes. As long as the first contribution was made at least
five years ago, Roth IRA distributions will not be subject to
federal income taxes. Generally, you should postpone withdrawals
as long as possible to continue tax-advantaged growth. However,
in years when income is low, you may want to take distributions
from a traditional IRA to take advantage of lower income tax rates.
You may also want to convert all or part of a traditional IRA
to a Roth IRA during low income years. While you will have to
pay income taxes on the conversion, future earnings will accumulate
tax free as long as you make qualified distributions.
After Age 70 1/2
You are not required to take distributions
from a Roth IRA after age 70 1/2. You must, however, take required minimum distributions
(RMDs) from your traditional IRAs every year or you will be assessed
a 50% federal income tax penalty on amounts that should have been
withdrawn. You can always take more out than the RMD. Your RMD
is calculated by taking the account balance as of the preceding
year divided by the life expectancy factor from a uniform table.
The table is based on joint life expectancies and assumes your
beneficiary is 10 years younger than you. If your spouse is your
sole beneficiary and is more than 10 years younger, you can use
either the uniform table or a table based on the actual joint
life expectancy of you and your spouse.
Your first RMD must be made by the required
beginning date (RBD), which is April 1 of the year after you turn
70 1/2.
However, if you take the distribution in the following year, you
will then take both your first and second distribution in the
same year. Evaluate your tax situation before doing that. Two
distributions may increase your income so you are in a higher
tax bracket, lose tax deductions or credits, or Social Security
benefits become taxable. In those situations, you may be better
off taking your first RMD in the year you turn 70 1/2.
After Death
Heirs must generally start taking distributions
by December 31 of the year after your death. Distributions by
heirs are based on who your beneficiary is and whether you died
before or after the RBD:
- If the account has a designated beneficiary,
which includes individuals and certain trusts, the account balance
is paid out over the beneficiary's life expectancy, based on
a single life expectancy table. This calculation is used whether
you die before or after your RBD. If the designated beneficiary
is older than you, he/she can use your remaining life expectancy.
- A spouse can treat an inherited IRA as
his/her own, but the surviving spouse has to be the sole beneficiary.
However, if a spouse and other beneficiaries inherit an IRA,
the account can be split so the spouse solely owns his/her share.
- If the account does not have a designated
beneficiary, which includes your estate, charitable organizations,
and certain trusts, and you die after your RBD, the balance is
paid out over your remaining life expectancy. If you die before
your RBD, then the balance is paid out within five years of your
death.
The decisions you make regarding IRA withdrawals
have important consequences for your retirement and for your heirs.
[PRINTER FRIENDLY VERSION]
