If you've invested your retirement savings in a traditional IRA, you'll be obligated to start making minimum IRA withdrawals in the year in which you turn age 70 ½ (or the following year). But why do you have to take these minimum IRA withdrawals? And how do you initiate the withdrawals correctly in order to avoid unnecessary penalties and taxation?
For starters, taking minimum IRA withdrawals may actually be a benefit for you in that the IRS allows you to take these withdrawals in small amounts over time. When you contribute to a traditional IRA, you do so with pre-tax contributions, which means that any IRA withdrawals you make in retirement will be taxed at your ordinary income rate. Assuming you were in the 25% tax bracket while working (and benefited at that rate when you made tax-deductible IRA contributions) and you are in the 15% tax bracket at retirement, the government has allowed you quite a savings even though you are forced to pay some tax on your minimum IRA withdrawal. By allowing the IRA withdrawals to be taken and taxed over time, you avoid being pushed into a higher IRA tax bracket.
These smaller payments spread out over time will encourage you to keep your retirement savings intact and earning interest for longer when compared with taking a lump sum taken at the beginning of retirement. Of course, there's an advantage for the US government as well to these forced IRA withdrawals. The IRS gets to collect the tax that they have been waiting for. By forcing these at age 70 1/2, the IRA does not need to wot longer until some later point such as death. By the way, should you forget or intentionally not take your mandatory IRA distribution, the penalty is 50% of the amount you did not take. So when IRS catches you, you'll have the penalty PLUS the income tax you tried to avoid.
So, when it comes time for you to start making required IRA minimum distributions, how do you calculate the amount due? In most cases, the trustee of your traditional IRA will perform the calculations needed and will send you any necessary paperwork to ensure that your distributions are set up correctly.
However, as it is ultimately your responsibility to ensure that the correct amount of required minimum distributions IRA withdrawals are paid out, it's wise to go over these calculations yourself as well. To determine how much your required IRA minimum distributions will be, consult IRS Publication 590, Individual Retirement Arrangements (IRAs). This document contains the actuarial tables used to determine your estimated life expectancy and calculate your required minimum IRA withdrawal. Note that after the first year, a withdrawal is required each year thereafter.
If you have any questions regarding how to calculate your required IRA minimum distributions amount, it's a good idea to consult with either your IRA custodian or a qualified tax planner,and avoid the onerous IRA penalty.
Lose a Fortune on Your 401k Rollover
If you do not do any of these correctly:
- Opt for a distribution rather than direct transfer
- Rollover company stock to an IRA
- Choose to rollover to a Roth IRA
- Rollover to your new employer’s 401k
- Rollover post-tax contributions